If the expenses are of revenue nature, then the same are to be allowed and section 35D will not be applicable
CASE LAW DETAILS
Decided by: ITAT, BANGALORE BENCH `B’ , In The case of: ACIT v Khoday India Ltd, Appeal No.: ITA No. 338/Bang/08, Decided on: December 12, 2008
4.1 The Assessing Officer from the details filed noticed that the assessee has claimed a sum of Rs.3,24,91,003/- as deferred revenue expenditure. The assessee vide letter dated 15th December, 2005 submitted that a new call center was in the process of being completed, but was not completed during the year. The expenditures is revenue in nature and therefore, this has been claimed in the current year. According to the Assessing Officer, setting up of call center is a new business of the assessee. The expenses are in the nature of preliminary expenses and are required to be capitalized. These expenses are not attributed the business of the assessee in the current year. Hence, these do not qualify to be set off against income to which they have no nexus. In view of the above, the Assessing Officer disallowed the claim of Rs.3,24,91,003/-. However, the Assessing Officer held that the assessee will be entitled to capitalize the Same as preliminary expenses of call Center” venture.
4.2 Before the learned Commissioner (Appeals), it was submitted that the assessee has earned income of Rs. 1,95,24,601/-from the call centre during the year ending 31st March, 2003 i.e. relevant to the asst. year under consideration. It was submitted that the list of expenses were furnished before the Assessing Officer and these list show that the; payments were largely consist of staff salaries, electricity charges, dish net charges, traveling expenses, staff food expenses etc. There was business of call center functioning during the year and such business was substantial. The fact that the assessee described the revenue expenditure as deferred revenue expenditure does not militate against the claim nor does not justify the inference that the amount paid is in the nature of capital expenditure. The call center is only an extension of-new line of business and not of new business by itself. There was already an established facility by leasing or otherwise. It is incorrect tb assume that there was no business at all. The law required that there should be a business during the year for allowing the expenses incurred during the year. Even there was a particular activity which forms part of business yet to be started or discontinued, deduction cannot be disallowed. Once business is set up, deduction becomes admissible by tests laid down by the following decisions:-
1) Ramraju Surgical Cotton Mills Ltd. v CIT (1967) 63 ITR 478 (SO
2) CIT v Sarabhai Management Corporation Ltd. (1991) 192 ITR 151 (SC)
3) CTT v Industrial Solvents & Chemicals P Ltd. (1979) 119 ITR 608 (Bom.) A
4) CIT v Western India Seafood Pvt. Ltd. (1993) 199 IT1* 777 (fcuj.) ;
Under the Company law, the expenditure has to be claimed when it is put to use. Hence, in accounts, it was treated as deferred revenue expenditure. In view of the above arguments and considering the fact that there is income of Rs.1.95 crore relating to business for which the expenditure was incurred, the learned CIT(A) held that the expenditure is allowable. The learned CIT(A) has referred to the decision of Hon’ble Apex Court in Ramraju Surgical Cotton Mills (supra).
4.3 During the course of proceedings before us, the learned CIT(A), DR has filed written submissions on this issue. Our attention was drawn towards the expenses debited under the head “rates and taxes. The assessee paid fees to RAC towards increase of authorized capital and stamp duty amounting to Rs.16,78,009/-. In view of the decision of the Hon’ble Apex Court in the case of Brook Bond India Ltd., such expenses are not revenue expenses. Other expenses like salaries, traveling expenses, rent, car hiring charges, advertisement etc. are not relatable to earning of income during the year. The learned DR pointed out that the AR admitted that expenses were not incurred towards setting up of new call center division at Kanakapura, Bangalore and no income was derived during the year from this facility. However, in the next para, the learned AR contradicted himself by mentioning that the company had earned income of Rs.1.9 crore for the year ending 31st March, 2003 i.e. asst. year 2003-04 from the lease premises. The learned DR drew our attention to the annual report for the financial year 2002-03. Page no.6 of the annual report contains report of the Director to the shareholders. The learned DR drew our attention to the following observation at page 6 of the annual report:-
“During the year under review, the company had not commenced the Call Center operations for M/s Khodays System Limited which has been merged with the Company with effect from 01.04.2002″.
Thereafter, the learned DR drew our attention to page 15 of the Annual Report. At page 15, it is mentioned that the Company is one of the leading manufacturers and distributors of high quality alcoholic beverages in the country, catering to both Indian and Overseas market. Of late the company has diversified its business activities by carrying on the business of High Quality Bottles and Printing and Writing Papers etc. Pursuant to the scheme of Amalgamation as approved by the Hon’ble High Court of Karnataka by its order dated 22nd August, 2003, Khodays Systems Ltd., the sister concern of the Khoday group was amalgamated with the Company thereby enabling the company to carry on the business of Information Technology as well. While highlighting the outlook for 2003-04, it is mentioned that the Company is geared up to meet the challenges by diversifying its activities into the area of information technology, paper and paper products and hope to capitalize on the opportunities open to the company in the year 2003-04. Thereafter, the learned DR drew our attention to page 38 of the annual report. In Schedule 23 of the annual report, it is mentioned that the operations of Khoday System Ltd. include trading of computers, embedded software solutions, software development and other proposed allied activities. From this, the learned DR inferred that there was no business of call center during the year. At page 34 of the annual report, it Is mentioned that deferred revenue expenditure is written off over a period of 5 years from the year of the commencement of commercial production. Schedule 14 to the Annual Report show that expenses have not been written off during the year and had indicated that the production has not started during the year. Running of call center was not a regular business of the assessee during the year under consideration. In view of the above submissions, it was urged that the expenditure is not allowable in view of section 35D of the IT Act.
4.4 On the other hand, the learned AR has filed a paper book containing/pages. It was submitted that the list of expenses were furnished to the A.O. The call center was not completed and there was no income derived from such facility during the year, therefore, the expenditure was shown as deferred revenue expenditure. The expenditure was claimed as deduction from the taxable income. The company has earned income of Rs.1,95,24,601/- from the call center during the year ending 31st March, 2003 relevant to asst. year 2003-04 which was carried on from the lease premises during the year. The learned AR enclosed copy of the letter dated 15th December, 2005 vide which the assessee has enclosed evidence of having paid the management fee to Customer Services Pvt. Ltd., Bangalore for using their facility during the year. The expenses debited are largely towards staff salaries, electricity charges, dish net charges, traveling expenses, staff food expenses etc. It is not true that the call center business was new business. It was only an extension of new line of business. There was already an established facility by leasing or otherwise. It is correctly assumed that there was no business at oil The learned AP also relied on the decisions which have been referred to by the learned CIT(A). The learned AR drew our attention to Schedule 15 of the annual report. Schedule 15 contains the details of sales of various divisions. Under the head ‘system division’, the assessee has shown receipts of Rs. 2,10,57,000/-. Such receipts included the receipts from the call center. The details of sales on system division has also been filed vide letter dated November, 2008. These details were filed as desired by the Bench. Call center details are of Rs.1,95,25,602/-. Rs.15,31,965/- are the ales of trading division. The learned AR filed the ledger account of technical service charges and has also enclosed copies of certain bills. From these details, the learned AR submitted that the business of call center was already in existence.
4.7 Section 35D was inserted by Taxation Laws Amendment Act, 1970 with effect from 1/4/1971. The CBDT issued Circular No.56 dated 19th March, 1971 to explain the provisions in the Taxation Laws Amendment Act, 1970. Para 42 and 43 of the Circular ere reproduced as under.-
“42. Section 8 of the Amending Act has introduced two new sections 35b and 35E with effect from 1/4/1971 New section 35b provides for the amortisation of certain preliminary expenses incurred by an Indian company or a resident assessee other than a company before the commencement of business or in connection with the extension of an industrial undertaking or the setting up of a new industrial unit. The amortisation will be allowed against the profits of the company or other taxpayer in 10 equal instalments over a period of 10 years beginning with the previous year in which the business commences or as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation. Such-amortisation will be allowed only in. respect of expenditure incurred after 31.3.1970 under specified heads. The heads of qualifying expenditure specified for this purpose are the following:
I Expenditure in connection with : (i) preparation of feasibility report; (ii) preparation of project report; (iii) conducting market survey or any other survey necessary for the business of the assessee; and (iv) engineering services relating to the business of the assessee.
These items of expenditure will qualify for amortisation where the work in connection with the preparation of the feasibility report or the project report or the conducting of the market survey or other survey or the engineering services, is carried out within the organization of the company or other assessee himself, or, where it is entrusted to an outside concern, such concern is, for the time being, approved for the purpose of this provision by the Central Board of Direct Taxes,
2. Legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee.
3. In the case of a company, in addition to the expenditure falling under items (1) and (2) above, the following items of expenditure will also qualify for amortisation:
a) legal charges for drafting the memorandum and articles of association of the company;
b) expenditure on printing of the memorandum and articles of association;
c) fees for registering the company under the provisions of the Companies Act, 1956; provisions of the Companies Act, 1956;
d) expenditure in connection with the issue, for public subscription, of share in or debentures of the company, by way of underwriting commission, brokerage and charges for drafting, typing, printiry and advertisement of the prospectus. [This will include legal charges and auditors’ fees for drafting of the prospectus].
The Central Board of Direct Taxes is also empowered to specify in the Income-tax Rules any other item or items of expenditure in respect of which the law does not provide for any allowance or deduction, and, thereupon the items of expenditure so specified will also be eligible for amortization under section 350.
43. The aggregate amount of the expenditure under all the specified heads will, for the purpose of amortisation be limited to 21/2 per cent of the cost of the project The ‘cost of the project* has been defined to mean the actual cost of the fixed assets, namely, land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the business of the assessee commences. Where the amortisation is to be allowed with reference to expenditure incurred in connection with the extension of an existing industrial undertaking or in connection with the setting up of a new industrial unit, the ‘cost of the project’ is defined to mean the actual cost of the fixed assets as stated above which are shown in the books of the assessee as on the last day of the previous year in which the extension of the industrial undertaking is -completed or, as the case-may be, the new industrial unit commences production or operation insofar as such fixed assets have been acquired or developed in connection with the extension of the industrial undertaking or setting up of the new industrial unit of the assessee”.
From the language of the section as well as from the Circular, it is clear that the expenses which are falling u/s 35(2) are to be considered for amortization u/s 35D, In a case where the business is already in existence, then the revenue expenses cannot be disallowed on the ground that business has not commenced. It is not the case of the revenue that business was not in existence. The details filed by the learned AR show that the company has shown receipts under the head ‘system division’. The learned AR has submitted that these receipts are from call center. Moreover, section 35b does not start with the word ‘notwithstanding anything contain in any other provisions of the Act’. Hence, an expenditure which is otherwise allowable, cannot be considered u/s 35D. If the expenditure is allowable u/s 37, then the same Is to be allowed. The Hon’ble Apex Court in the case of CIT v Swaraj Engineers Ltd. 171 Taxman 495 had an occasion to consider the applicability of section 35AB in respect of expenditure. The Hon’ble Apex Court observed as under:-
“At the same time it is important to note that even if the applicability of section 35AB, the nature of expenditure is required to be decided at the threshold because if the expenditure is found to be revenue in nature, then section 35AB may not apply. However, if it is found to be capital in nature, then the question of amortization and spread over as contemplated by section 35AB would certainty come into play”.
4.10 For the purposes of Company’s Act, the assessee has treated the expenditure as deferred revenue expenditure because no receipts were obtained from the call center which was being set up. However, the business of call center was already there and the assessee has shown receipts from them. One has to see the allowability of expenditure as per the provisions of the I T Act. The expenses debited are mainly of revenue nature and it is not necessary that these expenses will be allowable only when there are receipts. If the expenses are incurred for the purposes of business, then these are to be allowed. In the instant case, 35D(l)(i) is not applicable as the business has already commenced. 35D(l)(ii) is not applicable because it Is not the case of the extension of industrial undertaking. The assessee was earlier carrying out call center activities from a lease premises and now it was setting up of its own call center. Moreover, none of the expenses which have been claimed can be classified u/s 35D(2).
4.11 The issue of allowability of expenditure u/s 35D has been considered by the Hyderabad Bench in the case of ITW Signode India Limited (supra). The Hyderabad Bench has observed as under:-
“6. We have duly considered the rival contentions and the material on record. The Revenue has invoked the provisions of s.35b and has made the disallowance on the basis of the provisions of s,.35b(2)(a)(iii) of the Act The said sub-clause (iii) refers to expenditure incurred for conducting market survey or any other survey for the business of the assessee. Sub-s.(2)(a) in which this sub-clause is contained is with reference to the expenditure referred to in sub-s.(l) of S.35D. Sec.350(l) provides for a spread over of the expenses over ten assessment years with regard to certain preliminary expenses. For such amortization, the provision contemplates either of the two situations. The first situation is where expenditure is incurred before the commencement of business. In the present case, we are not concerned with this situation. The second situation is where the assessee incurs the expenditure after the commencement of business in connection with the extension of its industrial undertaking or in connection with the setting up of a new industrial unit. Since the assessee has commenced its business long back and has incurred the impugned expenditure after the commencement of its business, we have to appreciate the facts in the light of this situation. This second situation further visualizes either of the two situations. One is the expenditure is incurred in connection with the extension of its industrial undertaking. Let us examine whether the assessee’s case falls within this situation. The expression used is ‘extension’ and not ‘expansion’ The former connotes that the assessee has extended its operations from the present activity to another activity. On the other hand, the latter indicates that the assessee merely expanded its present operations. The expansion is generally meant to be the expansion of its present installed capacities. The capacity may be expanded either at the same location or at a different location. But the legislature has not used the word ‘expansion’ and that is with a purpose. If there is merely an expansion, then it may not be necessary for the assessee to incur the type of expenditure envisaged in s.350. On the other hand, if there is extension or where altogether a new industrial unit is set up, such extension or setting up of a new unit may be preceded with the preparation of a feasibility report or a project report or conducting market survey and so on. These preliminary expenses are envisaged in section 35D for the reason that the extension or setting up of a new unit presupposes that the assessee is entering into altogether a new line of activity or is setting up an undertaking which is independent of the present undertaking. With the background, let us consider the facts of the present case.
7. The assessee company is in manufacture of state or art packaging systems. It manufactures several products like steel strapping; sealing tools, industrial packaging machines, stretch wrapping and packing systems, paper conversion products etc. It is not unknown to anyone that the market gets flooded with new innovative products everyday. It is also not uncommon that the manufacturers of such products always try to package them in a sophisticated way to attract customers. Secondly, automation in every activity is the order of the day and hence new machines are also being evolved to hasten the process of packaging with efficiency and efficacy. The assessee therefore has to keep on innovating new products and improving the existing products to cope up with the expanding market and consumerism. For this it requires dedicated department which keeps on conducting surveys of various types. It is in connection with this department that the assessee has incurred various expenses. As mentioned by the assessee, this department has been treated as a separate cost center and hence its expenses are shown separately. To cope up with its expanding activities and production, the assessee has to install new plants or new machinery. Installing such new plants or machinery is sometimes looksely referred to as setting up a new unit The contention of the assessee before the CIT(A) that it has set up new units was in this context and not in the context in which it is envisaged in $.351). Therefore, there is no gainsaying that the assessee has put up new industrial unit and hence the expenditure in connection, therewith should be amortised under s.350. In the two Tribunal decisions the assessee had launched altogether a new product and had incurred huge advertisement expenditure. In both the cases, the expenditure was treated as deferred revenue expenditure by the assessee in its books of account. The assessee had claimed the entire expenditure in the return of income as revenue expenditure. The Tribunal allowed the entire capital expenses can be allowed as deduction in a ten year span i.e. 1/10 in each year. The Board has clarified in Circular No.56 dated March 19, 1971, that the provision for amortization is not intended to supersede any other provision of the income-tax law under which such expenditure is admissible as a deduction or deduction allowable by virtue of the decision of the Supreme Court in India Cements Ltd. vg CIT(1966) 60ITR 52″.
4.14 In the instant case, the assessee vide Annexure 5 of the paper book has filed the details of deferred revenue expenditure to the extent of fts.3,24,91,003/-. The details are as under:-
|Admin charges to PF||1,971.00|
|Or Hire charges||1,693,960.00|
|Computer Hire charges||106,750.00|
|Office Equipment hire charges||252,500.00|
|Office maintenance charges||214,776.00|
|Rates and Taxes||178009.00|
|Repairs and maintenance computers||4,764.00|
|Service charge teaching||60,000.00|
Travelling expenses-Inland Air Force
|Salaries Technical Staff||8,866,202.00|
|Printing and stationery||263,030.54|
|Boarding and lodging expenses||2,067,019.00|
|Staff food expenses||399,530.00|
|Travelling expenses Foreign Air fare||4,003,660.00|
|Employer’s contribution to ESI||82,840.00|
|Employer’s contribution to PF||36,675.00|
4.15 Sub-head wise details have also been filed. The AO has not examined all the expenses from the angle as to whether any of the expenditure is of capital nature. The AO has disallowed the expenses by holding that these are covered u/s 350. After considering the rival contentions, we are holding that if the expenses are of revenue nature, then the same are to be allowed and section 35D will not be applicable. Therefore, the AO will examine the details and in case any of the expenditure is in capital nature, then the same will not be allowed.