Arrow Greentech Limited Vs Asst. CIT (ITAT Mumbai)
Summary: The Mumbai “A” Bench of the Income Tax Appellate Tribunal partly allowed Arrow Greentech Limited’s appeal for AY 2017-18, deleting an additional disallowance of ₹11,64,635 under section 14A read with Rule 8D and restoring the ₹11,84,86,000 patent-royalty expenditure disallowance to the Assessing Officer for fresh verification. The company, engaged in manufacturing water-soluble films and bio-compostable products, had returned income of ₹14,57,96,930. Its assessed income was ₹26,54,47,563, and the CIT(A) had confirmed both disputed additions.
On section 14A, the Assessing Officer proceeded on the assumption that the assessee had made no disallowance against exempt dividend income of ₹70,15,868. However, the computation and assessment-stage reply showed a suo motu disallowance of ₹16,86,936. The Tribunal held that the Assessing Officer had neither examined this actual claim with reference to the accounts nor recorded the dissatisfaction required by section 14A(2). Observations directed at a supposed nil-expenditure claim could not satisfy that condition. It therefore deleted the additional ₹11,64,635, including the consequential adjustment to book profit under section 115JB, while leaving the assessee’s own ₹16,86,936 disallowance undisturbed.
The second issue concerned expenditure attributable to royalty income under section 115BBF. The Assessing Officer treated the entire royalty revenue as 72.35% of operating revenue and applied that percentage to total expenditure. The assessee submitted that only ₹12,52,61,284 relating to six patents was offered under section 115BBF; royalty from two other patents was offered as ordinary business income because those patents had not been granted by 31 March 2017. It also contended that ₹2,34,87,110 of expenditure had already been disallowed and that several manufacturing and trading expenses had no nexus with royalty income.
The Tribunal held that expenditure connected with qualifying royalty could not reduce other business income while the corresponding gross royalty enjoyed the special rate. However, section 115BBF(2) did not permit indiscriminate allocation of every expense merely by reference to gross receipts. Admitting a Chartered Accountant’s certificate as additional evidence under Rule 29, it directed the Assessing Officer to identify qualifying royalty, exclude expenses already disallowed, examine the nature and nexus of each material expense class, and recompute only attributable expenditure after hearing the assessee. The final disallowance was left open. Interest under sections 234B and 234C was consequential.
Cases Discussed
- JCIT v. American Express Bank Ltd., [2012] 19 ITR (Trib.) 650 (ITAT Mumbai) — Cited by the assessee, without prejudice, in its submissions concerning the basis and quantum of expenditure allocation. The Tribunal remanded the issue for factual verification without expressly adopting a proposition from this precedent.
FULL TEXT OF THE ORDER OF ITAT MUMBAI
1. This appeal by the assessee is directed against the order dated 26.09.2025 passed by the National Faceless Appeal Centre, Delhi [hereinafter referred to as ‘the learned CIT(A)’], under section 250 of the Income-tax Act, 1961 (‘the Act’), arising from the assessment order dated 18.12.2019 passed by the Assistant Commissioner of Income-tax, Circle 9(1)(2), Mumbai (‘the Assessing Officer’) under section 143(3) of the Act for the assessment year 2017-18.
2. The assessee has raised the following grounds of appeal:
“1. On the facts and in the circumstances of the case and in law, the Appellant respectfully challenges the order dated 26.09.2025 passed under section 250 of the Act upholding the assessment order dated 18.12.2019 passed under section 143(3) of the Act.
2. Disallowance under section 14A read with Rule 8D – ₹11,64,635/-
(a) The learned CIT(A) erred in upholding the disallowance of ₹11,64,635/- under section 14A of the Act.
(b) The learned CIT(A) erred in observing that the Appellant had not offered any suo motu disallowance, without appreciating that the Appellant had already disallowed ₹16,86,936/- in its return of income.
(c) The learned CIT(A) failed to appreciate that Rule 8D could be invoked only after recording satisfaction regarding the incorrectness of the Appellant’s claim, which satisfaction was not recorded by the Assessing Officer.
3. Ad hoc disallowance of expenses under section 115BBF(2) – ₹11,84,86,000/-
(d) The learned CIT(A) erred in upholding the ad hoc disallowance of ₹11,84,86,000/- under section 115BBF(2) of the Act.
(e) The learned CIT(A) failed to appreciate that section 115BBF(2) was not applicable in the manner adopted by the Assessing Officer.
(f) The learned CIT(A) failed to appreciate that the Appellant’s books were audited under section 44AB and that no defect was pointed out therein; hence, the expenditure could not be bifurcated on an ad hoc basis.
(g) The learned CIT(A) failed to appreciate that the expenditure debited to the Profit and Loss Account related to the manufacturing and trading activities and that the turnover ratio was not an appropriate basis for determining expenditure attributable to royalty income.
4. The Appellant denies its liability to interest under sections 234B and 234C of the Act.
5. The Appellant craves leave to add, alter, amend, delete, rescind or withdraw any of the above grounds.”
3. Briefly stated, the assessee is engaged in the manufacture of water-soluble films and bio-compostable products. It filed its return of income on 30.11.2017 declaring total income of ₹14,57,96,930/- under the normal provisions and book profit of ₹2,75,05,088/-. The case was selected for scrutiny and the assessment was completed under section 143(3) at a total income of ₹26,54,47,563/-. The Assessing Officer made a disallowance of ₹11,64,635/- under section 14A read with Rule 8D and a further disallowance of ₹11,84,86,000/- under section 37 read with section 115BBF(2). The learned CIT(A) confirmed both additions. The assessee is, therefore, in appeal before us.
4. Ground no. 1 is general and does not require separate adjudication.
5. Ground no. 2 concerns the disallowance under section 14A read with Rule 8D. The Assessing Officer noticed exempt dividend income of ₹70,15,868/-. Proceeding on the premise that the assessee had not made any disallowance in its computation of income, he applied Rule 8D(2)(ii) and computed one per cent of the annual average of the monthly averages of investments at ₹11,64,635/-. This amount was added both while computing income under the normal provisions and while computing book profit under section 115JB. The learned CIT(A) affirmed the action of the Assessing Officer on the ground that the assessee had not positively demonstrated the suo motu disallowance claimed by it.
6. The learned Authorised Representative submitted that the very foundation of the impugned disallowance is factually incorrect. Our attention was drawn to Schedule 3 of the computation of income and to the reply furnished during assessment proceedings, which show that the assessee had itself disallowed ₹16,86,936/- in relation to exempt income. It was submitted that the Assessing Officer neither considered this amount nor examined its correctness before invoking Rule 8D. The learned Departmental Representative relied upon the orders of the authorities below.
7. We have considered the rival submissions and perused the material on record. Section 14A(2), as applicable to the year under consideration, permits the Assessing Officer to determine expenditure in accordance with the prescribed method only if, having regard to the accounts of the assessee, he is not satisfied with the correctness of the assessee’s claim. The requirement is not an empty formality. The Assessing Officer must first notice the claim actually made by the assessee, examine it with reference to the accounts and record why it is not correct. Only thereafter can the machinery of Rule 8D be applied.
8. In the present case, the computation of income placed on record shows a suo motu disallowance of ₹16,86,936/-. The Assessing Officer nevertheless proceeded throughout on the contrary premise that no amount had been disallowed. The general observations recorded in paragraph 3.3 of the assessment order address a claim of nil expenditure and do not examine the correctness of the actual disallowance of ₹16,86,936/-. The Assessing Officer thus did not consider the assessee’s claim at all, much less record dissatisfaction with that claim having regard to the accounts. The jurisdictional condition for applying Rule 8D was therefore not fulfilled. We also note that the further disallowance computed by the Assessing Officer at ₹11,64,635/- is itself lower than the disallowance already offered by the assessee. In these facts, no additional disallowance was called for. We accordingly direct the Assessing Officer to delete the further disallowance of ₹11,64,635/-, including the consequential adjustment made on this account while computing book profit under section 115JB. The assessee’s own disallowance of ₹16,86,936/- shall remain undisturbed. Ground no. 2 is allowed.
9. Ground no. 3 relates to the disallowance of ₹11,84,86,000/- in connection with royalty income offered under section 115BBF. The Assessing Officer noticed total operating revenue of ₹315.984 million, including royalty revenue of ₹228.610 million, and worked out royalty revenue at 72.35 per cent of total operating revenue. He further noticed total expenditure of ₹163.771 million. Since, according to him, the assessee had charged the entire expenditure against its other business streams, he attributed 72.35 per cent of the total expenditure to royalty revenue and disallowed ₹11,84,86,000/- under section 37 read with section 115BBF(2). The learned CIT(A) agreed that expenditure attributable to royalty income taxable at the concessional rate could not again reduce income taxable at the normal rate and affirmed the disallowance.
10. Before us, the learned Authorised Representative did not dispute that expenditure properly attributable to royalty income governed by section 115BBF has to be identified in accordance with law. His principal objection was to the basis and quantum adopted by the Assessing Officer. It was submitted that total royalty income of ₹22,86,09,908/- arose from eight patents, but royalty of only ₹12,52,61,284/- relating to six patents was offered under section 115BBF at the prescribed rate. Royalty of ₹10,33,48,625/- relating to the remaining two patents was offered as business income under section 28 because the patents had not been granted as on 31.03.2017. Consequently, royalty governed by section 115BBF constituted about 39.66 per cent of the operating revenue and not 72.35 per cent. It was further submitted that, out of the total expenditure of ₹16,37,70,000/-, expenditure aggregating to ₹2,34,87,110/- had already been disallowed under various provisions and could not again form part of the allocation base. Several items, including raw materials, stock-in-trade, factory charges, labour charges, electricity, water charges, repairs and maintenance, were stated to have no nexus with royalty income. The learned Authorised Representative also tendered additional evidence in the form of a certificate issued by a practising Chartered Accountant estimating, with reference to the books, expenditure relatable to royalty income. He requested that the certificate and supporting records be examined by the Assessing Officer. Without prejudice, reliance was placed on JCIT v. American Express Bank Ltd. [2012] 19 ITR (Trib.) 650 (Mumbai). The learned Departmental Representative supported the orders below and submitted that any fresh evidence and factual allocation would require verification by the Assessing Officer.
11. We have considered the rival submissions. Section 115BBF(1) provides a special rate of tax on qualifying royalty income from a patent developed and registered in India. Sub-section (2), which begins with a non obstante clause, provides that no deduction in respect of any expenditure or allowance shall be allowed under any provision of the Act in computing the income referred to in section 115BBF(1)(a). Thus, expenses having a nexus with the qualifying royalty stream cannot be used to reduce the other business income while the corresponding gross royalty enjoys the special rate. At the same time, the amount to be so excluded must rest on relevant facts and a reasonable nexus. Section 115BBF(2) does not authorise an indiscriminate allocation of every item in the Profit and Loss Account merely in the ratio of gross receipts.
12. The Assessing Officer adopted 72.35 per cent by taking the entire royalty of ₹22,86,09,908/- as the numerator. The assessee’s specific contention is that only ₹12,52,61,284/- was offered under section 115BBF and that the balance royalty of ₹10,33,48,625/- was assessed at the normal rate. This distinction has a direct bearing on the allocation. The Assessing Officer also applied the percentage to the gross expenditure of ₹16,37,70,000/- without examining whether the base included expenditure already disallowed or expenditure exclusively connected with manufacturing and trading operations. These matters require verification from the return, computation, patent-wise royalty details, ledgers and books of account. The Chartered Accountant’s certificate now produced is relevant to that inquiry and goes to the root of the quantum. Since the lower authorities had no occasion to verify it and the assessee itself seeks such verification, we admit the additional evidence under Rule 29 of the Income-tax (Appellate Tribunal) Rules, 1963, in the interest of substantial justice.
13. We accordingly set aside the finding of the learned CIT(A) on the quantum of disallowance and restore this limited issue to the file of the Assessing Officer. The Assessing Officer shall verify the additional evidence and the underlying books and records; first identify the royalty income actually chargeable under section 115BBF; exclude from the allocation base expenditure already disallowed elsewhere; examine the nature and nexus of each material class of expenditure; and thereafter recompute only the expenditure, if any, attributable to the qualifying royalty income in accordance with section 115BBF(2). An expenditure shall not be attributed merely because royalty forms part of the consolidated revenue, nor shall the same expenditure be disallowed twice. The assessee shall be afforded a reasonable opportunity of being heard and shall furnish all supporting records called for. We have expressed no view on the final amount to be disallowed. Ground no. 3 is allowed for statistical purposes.
14. Ground no. 4, relating to interest under sections 234B and 234C, is consequential. The Assessing Officer shall recompute the interest, if any, while giving effect to this order. Ground no. 5 is general and requires no adjudication.
15. In the result, the appeal filed by the assessee is partly allowed for statistical purposes.
Order pronounced in the open court on 17/09/2026.
