Compensation Received would be Capital in nature if Cost of Project gone down

Tata Advanced Systems Limited Vs ACIT (ITAT Mumbai)

Conclusion:  In present facts of the case, the Hon’ble Tribunal by relying on the previous Judgments of the Tribunal in assessee’s own case for previous Assessment Years held that the compensation so received by the assessee company would only go to reduce the cost of project as it is effectively meant to cover up for the expenses and investments incurred by the assessee for the said project. Hence, the receipt of compensation would be capital in nature and would go to reduce the cost of project.

Facts: The issue to be decided in this appeal was with regard to taxability of compensation received by the assessee company during the Asst Year 2013-14 amounting to Rs 7,34,25,476/- towards interest cost; Rs 11,46,651/- towards insurance cost and Rs 10,15,04,000/- towards cost of modification and validation of the assets , warranty, restating etc.

The Hon’ble Tribunal observed that the assessee company had entered into the agreement for production of the floor beams for Dreamliner project. Due to the delay, the interest and insurance cost connected to the production of capital assets of assessee was affected and cost meter related to it was continuously increasing beyond the expected budgets. Due to this reason, compensation was paid to the assessee for interest and insurance cost incurred by the assessee and to offset the extra cost incurred by the assessee for the project. The said compensation was credited to profit and loss account in the books of accounts. However, for the purpose of income tax, the same was reduced from the total income being capital receipt not chargeable to tax. The delay in project was due to further change in specifications due to which the project was further delayed because of which compensation was paid to the assessee.

The Hon’ble Tribunal observed that the very same issue came up for consideration before this Tribunal in assessee’s own case for the Asst Years 2010-11, 2011-12 and 2012-13 and this Tribunal vide its order dated 27.10.2021 had adjudicated the same and held that the compensation received by the assessee would go to reduce the cost of project of the assessee company. In the said previous Tribunal order, it was observed as under:

1. Due to certain reasons production was delayed and as assessee have made all investments, the assessee was compensated by the other party.

2. As per terms and conditions between assessee and other party, it was deciphered out that the other party could make modifications to the project and suspend the work. In accordance to which assessee could make claims.

3. The compensation received was in connection with interest expenditure of Rs. 15,80,29,570/- and insurance related expenses of Rs52,09,915/- related to the said project. The said compensation figure was determined on the borrowing costs at approximate rate of 12 to 13% of the investment and other costs incurred by the assessee company.

4. The assessee treated that receipt of aforesaid compensation as capital receipt as it was received due to suspension of operations at the behest of the other Company itself. Moreover, it was also pleaded that the interest cost and all other incidental expenses incurred by the assessee for the said project had been capitalized and hence the receipt of compensation would only go to reduce the cost of project of the assessee company.

5. The compensation so received by the assessee company would only go to reduce the cost of project as it is effectively meant to cover up for the expenses and investments incurred by the assessee for the said project. Hence, it was that the receipt of compensation would be capital in nature and would go to reduce the cost of project.

6. Similarly all expenditure incurred by the assessee including Rs 3,75,34,846/- (which was claimed as revenue expenditure by assessee) should also be capitalized to the Capital Work in Progress.

The Hon’ble Tribunal on basis of the observations made by the Hon’ble Tribunal in previous Assessment Years, observed that it is not in dispute that the compensation is received by the assessee for validation support services, asset modifications etc proposed. Therefore, the compensation received is akin to the character of compensation received by assessee towards interest and insurance cost. Therefore, the decision rendered by this tribunal for compensation received towards interest and insurance cost supra would squarely be applicable for compensation received for validation support services, warranty, asset modifications etc also. Therefore, it was held that the compensation received by the assessee in Asst Year 2013-14 of Rs 7,34,25,476/- towards interest cost ; of Rs 11,46,651/- towards insurance cost and of Rs 10,15,04,000/- towards validation support services, warranty, asset modifications etc would go to reduce the cost of aerospace project of the assessee company.

Accordingly, appeals of the Assesee were allowed.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

These appeals in ITA Nos.89/Mum/2020 & 90/Mum/2020 for A.Yrs.2013-14 & 2014-15 arise out of the order by the ld. Commissioner of Income Tax (Appeals)-6, Mumbai in appeal No.CIT(A)-6/IT-106/2016-17 & CIT(A)-6/IT-105/2016-17 respectively dated 23/10/2019 & 17/10/2019 respectively (ld. CIT(A) in short) against the order of assessment passed u/s.143(3) of the Income Tax Act, 1961 (hereinafter referred to as Act) dated 29/12/2016 by the ld. Asst. Commissioner of Income Tax, Circle-2(3)(1), Mumbai (hereinafter referred to as ld. AO).

Identical issues are involved in both these appeals and hence they are taken up together and disposed of by this common order for the sake of convenience.

2. The only identical issue to be decided in this appeal is with regard to taxability of compensation received by the assessee company from Boeing Co. during the Asst Year 2013-14 amounting to Rs 7,34,25,476/- towards interest cost ; Rs 11,46,651/- towards insurance cost and Rs 10,15,04,000/- towards cost of modification and validation of the assets , warranty, restating etc.

3. We have heard the rival submissions and perused the materials available on record. We find that the assessee company had entered into the agreement with Boeing Ltd for production of the floor beams for Dreamliner project. Due to the delay on the part of Boeing Ltd, the interest and insurance cost connected to the production of capital assets of assessee was affected and cost meter related to it was continuously increasing beyond the expected budgets. Due to this reason, Boeing Ltd agreed to pay compensation to the assessee for interest and insurance cost incurred by the assessee and to offset the extra cost incurred by the assessee for the Boeing project. The said compensation received by the assessee has been credited to profit and loss account in the books of accounts. However, for the purpose of income tax, the same was reduced from the total income being capital receipt not chargeable to tax. The delay in project was due to further change in specifications by Boeing due to which the project was further delayed because of which Boeing has agreed to compensate the assessee. The said facts is also disclosed in the Directors’ Report for the year ending 31.3.2013 as under:-

“Business Overview

Due to the change in design from “Hybrid Titanium Floor Beams” to “Advanced Composite Floor Beams (ACFB)” by Boeing for their 787 Dreamliner Program, modified contract agreement was signed with Boeing during FY 2012, Accordingly, to meet the modified requirement, new set of facilities have been created at Nagpur and project activities are being progressed in line with the mutually agreed project schedule. The Company is also exploring business opportunities with other international aerospace OEMs such as Airbus. Pratt & Whitney, Rolls Royce etc.

Operations

To undertake the production of new advanced composite floor beams (ACFB) for Boeing 787 Dreamliner, TAL and Boeing have been working together to build-up the manufacturing facilities and factory set-up as per the new engineering and technological requirements. The special processes have been NADCAP approved and the manufacturing facility has been qualified to manufacture aerospace components. The Company has already commenced the production and supply of metal fittings for the initial sets of floor beams being produced by Boeing at their development center (ADC). Manufacturing of composite pre-production manufacturing (PPM) beams has started, after the successful qualification of composite facility by Boeing. The manufacture and supply of the complete floor beams are expected to commence during the later part of the FY 13-14,

12. The commercial production was further delayed and the said fact is also disclosed as under Note 38(a) of Financial Statements (Refer Page 52A)

“The Company is incurring, inter alla, borrowing cost and incidental expenses in setting up the project which was expected to commence commercial operations in April 2009. Boeing is compensating the Company for the delay in completion of the Project resulting from its actions and accordingly, with effect from April 2009, the incidental expenses and borrowing costs incurred on the Project are not being capitalized but are charged to Statement of Profit and Loss and the related compensation received is credit to Statement of Profit and Loss upto 31 July, 2012. The commercial production of Composite Beam is further delayed and Company has initiated discussions with Boeing for compensation of incidental expenses for the period commencing 1 August 2012. Pending completion of this process, the incidental expense incurred with effect from 1 August 2012 relating to Composite Floor Beam are being capitalized.”

3.1. We find that the assessee company commenced commercial production of floor beams at Nagpur with effect from 29.3.2015 which fact is also mentioned in the financial statements for the year ended 31.3.2015 placed on record before us.

3.2. At the outset, the ld. AR before us stated that the very same issue came up for consideration before this Tribunal in assessee’s own case for the Asst Years 2010-11, 2011-12 and 2012-13 and this Tribunal vide its order dated 27.10.2021 had adjudicated the same and held that the compensation received by the assessee from Boeing Co. would go to reduce the cost of aerospace project of the assessee company. The relevant operative portion of the said tribunal order which narrates the entire facts and adjudication thereon are reproduced below:-

2.1. We have heard the rival submissions and perused the materials available on record. We find that the assessee company is engaged in the business of manufacturing of machines, jigs, fixtures, equipment, material handling system, fluid power solutions etc having its existing manufacturing unit in Pune. As part of new business expansion plan, the assessee began setting up an infrastructure for providing aerospace solutions at MIHAN SEZ area in Nagpur in the year 2008. The project with Boeing Co. was entered into by assessee for expansion of its existing business, for which purpose, an agreement was entered in February 2008 for supply of floor beams (as per their specification) for the Dreamliner range of aircrafts launched by Boeing Co. The infrastructure for providing aerospace solutions was ready for production in March 2009. Till the time the commercial production could be started, all costs incurred by the assessee for the expansion project was directly capitalized as part of Work in Progress (WIP). Subsequently there was change in design by Boeing Co. because of which commercial production was delayed by the assessee on request of Boeing Co. Accordingly, the manufacturing operations of assessee for this expansion project were temporarily suspended. Since assessee had already made all the investments, employed people for the said project and was ready to start production, assessee was provided compensation by Boeing Co. for such outlays of expenditures incurred. This fact has also been disclosed in the notes to the annual report vide page 18 of the factual paperbook dated 04/01/2018. The relevant extract is reproduced below:

“The major contract signed with The Boeing Company for supply of Hybrid Titanium Floor Beams for its new 787 Dreamliner airplanes has undergone some changes in the definition of the product requirements, due entirely to the Boeing Company. The Company is continuing to work on setting up the facilities as per their modified requirement, in line with Boeing’s new changed product configuration.

This fact was also disclosed in the Director’s report of the Financial Statements prepared for the year under consideration vide page 5 of the factual paperbook dated 04/01/2018). The relevant extract is reproduced below:

“As a part of a unique concurrent engineering work methodology, Boeing and TAL are working together to buildup the engineering technology, facilities and factory set-up to their new changed configuration. Though, Boeing have announced two set of delays and a new modified product configuration during the year, for their Dreamliner program, the current interactions indicate that there are no further major impacts on the program and the Company’s supplies are expected to commence from 11-1-2012″

2.2. The assessee had made huge investments towards expansion of its business activities and total investment made in this project till 3103/2010 was Rs. 113.58 crore. The assessee submitted the details of such capital investment before the ld AO vide letter dated 21/12/2012 as under:-

2.3. Further, the assessee has also submitted before the ld. AO the reason for receiving the compensation and the treatment of compensation received in books of accounts of assessee vide its letter dated 08/01/2013 enclosed in pages 67 to 68 of the paper book. The ld AR before us also drew our attention to page 200 of the paper book filed for the AY 2012-13 to suggest that as per the terms of agreement with Boeing, Boeing is entitled to make modifications to project vide clause 10 of the agreement, or suspend the work vide clause 15 of the agreement and as per the said clauses, the seller may assess the cost incurred by it and make a claim for the same. The relevant extract from Clause 10 of the agreement is reproduced below:

“10.1…

if such change increases or decreases the cost or time required to perform this contract, Boeing and Seller shall negotiate an equitable adjustment in the price or schedule, or both, to reflect the  increase or decrease. ….”

2.3.1. The ld AR also submitted that this was disclosed in Annual Report of the assessee at Page 18 of paper book as under:

“26. The Company is setting up a Greenfield facility at MIHAN SEZ area (Nagpur) for catering to manufacturing requirements of the long term supply contract executed with the Boeing Company, USA (Boeing) and towards this end the Company is incurring interalia borrowing cost and incidental expenses. The facility was expected to commence manufacture in April 2009, but has been delayed by almost two years due to delays at customer end. However, Boeing is compensating the Company for the delay in the overall project. Consequently, with effect from April 2009, the incidental expenses and borrowing cost on the facility are not capitalized but charged to the Profit and Loss account and the relevant compensation amounts credited to the Profit and loss account. “

2.4. The ld AR submitted that the compensation received from Boeing Co. was in connection with interest expenditure of Rs. 15,80,29,570/- and insurance related expenses of Rs52,09,915/- related to the said project. The said
compensation figure was determined by Boeing Co. based on the borrowing costs at approximate rate of 12 to 13% of the investment and other costs incurred by the assessee company on the project in the normal course of its business. Hence it was pleaded that the assessee was reasonably compensated as per the prevailing terms of the agreement by Boeing for suspension of the aerospace project, which happened at the behest of Boeing Co. The assessee treated that receipt of aforesaid compensation as capital receipt as it was received from Boeing Co. due to suspension of operations at the behest of Boeing Co. Moreover, it was also pleaded that the interest cost and all other incidental expenses incurred by the assessee for the said project had been capitalized and hence the receipt of compensation would only go to reduce the cost of project of the assessee company.

2.5. The plea of the assessee that the compensation received would be capital receipt not chargeable to tax was rejected by the ld AO on the ground that the compensation received is akin to interest loss borne by the assessee for the delay in execution of the project by the Boeing Co. and accordingly the ld AO held that the said interest would be liable to be taxed separately under the head ^„income from other sources‟.

2.6. With regard to expenses pertaining to Boeing Project, the assessee had incurred expenditure amounting to Rs 4,79,10,331/- pertaining to Boeing Project, out of which, a sum of Rs 1,03,75,485/- was capitalised by the assessee comprising of interest of Rs 94,07,192/- and insurance of Rs 9,68,293/- and the balance sum of Rs 3,75,34,846/- pertaining mainly to employees and employee related expenses which were incurred in normal day to day basis towards business of the assessee company was claimed as revenue expenditure on the ground that they were incurred on routine manner. The ld AO however, disallowed the same on the ground that the said expenditure pertains to Boeing Project and since the project had not commenced during the year, he held that the said expenditure should be capitalized to the project.

2.7. The ld AR before us stated that both the receipt of compensation as well as the expenditure incurred for the Boeing Project need to be capitalized and should be included as part of work in progress. Per Contra, the ld DR vehemently supported the orders of the lower authorities by stating that the nature of receipt of compensation was not even established by the assessee company in the instant case and that the agreement with Boeing did not provide for payment of any compensation, which makes the nature of receipt itself questionable. Accordingly he argued that the so called receipt of monies from Boeing Co. termed as compensation should be treated as interest earned prior to commencement of business and taxed separately under the head ^„income from other sources‟ in the light of decision of Hon‟ble Supreme Court in the case of Tuticorin Alkali Chemicals reported in 227 ITR 172 (SC).

2.8. It is not in dispute that the assessee had entered into aerospace project with Boeing Co. and started making investments in the said project. Though the assessee was ready to commence its activities from the said project during the year under consideration, the same got delayed at the behest of Boeing Co. as they were suggesting some modifications in the execution. Accordingly, Boeing Co. delayed the execution of the project and since the assessee had already spent substantial sums in the said project, Boeing Co. decided to compensate the assessee company reasonably. It is not in dispute that the entire interest expenditure together with insurance and other project related expenditure had been duly capitalized by the assessee to the cost of project and reflected as Capital Work in Progress. It is not in dispute that the aerospace project had indeed undergone lot of changes including change in product configuration at the behest of Boeing Co. These facts are duly reported in the Annual report of the assessee company. We find that the agreement entered into with Boeing Co. did indeed provide for compensation in a different way vide clause 10.1. thereon reproduced supra. Therefore, it would be incorrect to say that there is no basis for compensation received by the assessee. It should be appreciated that when such events occur between parties, there is a lot of negotiations and mutual understanding between the parties to the agreement and basis the agreement and negotiations, the compensation, etc is decided. Accordingly, we do not find any abnormality in Boeing Co. coming forward to compensate the assessee company for the delay which happened at the behest of Boeing Co. and assessee could not be faulted at all for the same. What is relevant to decide is the nature of compensation received by the assessee. In the instant case, we find that the compensation so received by the assessee company from Boeing Co. would only go to reduce the cost of project as it is effectively meant to cover up for the expenses and investments incurred by the assessee for the said project. Hence we hold that the receipt of compensation would be capital in nature and would go to reduce the cost of project. The decision relied upon by the ld DR on Tuticorin Alkali Chemicals reported in 227 ITR 172 (SC) would not be applicable here as the said case pertains to interest earned from banks which were invested out of idle funds lying with the assessee prior to commencement of business. We find that the said decision of Hon’ble Supreme Court is completely on different facts wherein amount of share application money was invested in Fixed Deposits and the business was neither set up nor started. Whereas in the present case, the business of assessee was set up and had started and there was huge investment made by assessee and the project was only temporarily suspended by the Boeing Co. Therefore, the said case cannot be applied to the facts of the present case. Here what is received by the assessee is part of overall cost of project in the form of compensation from Boeing Co. which cannot be treated as interest. Accordingly, we hold that the compensation received in the sum of Rs 16,32,39,485/- would go to reduce the cost of aerospace project of the assessee company. Hence the Ground Nos. 1.1. to 1.8. raised by the assesseefor the Asst Year 2010-11 are disposed of in the aforesaid manner.

2.9. With regard to the interconnected issue of claiming a sum of Rs 3,75,34,846/- as revenue expenditure by the assessee company, we find that the break up of the said expenditure are as under:-

2.10. We find that the assessee had incurred expenses amounting to Rs. 4,79,10,331/- in relation to the Boeing project. Out of which, the assessee capitalized amount of Rs. 1,03,75,485/- (pertaining to the Interest component of Rs. 94,07,192 & insurance component of Rs. 9,68,293) relating to capital assets. The balance amount of Rs. 3,75,34,846/- which were recurring day-to-day expenses of the business were claimed as deduction while computing total income chargeable to tax. This was done by the assessee primarily on the ground that the business was already set up and ready for production but could not be taken forward due to product change configuration stated by Boeing Co. We find that the ld DR tried to question the commercial rationale of such expenses incurred by the assessee. But we find from the orders of the lower authorities that nowhere they had doubted the commercial rationale of incurrence of such expenses for the Boeing project. The ld DR cannot improve the case of the revenue and cannot travel beyond what is stated in the orders of the lower authorities. The only limited argument of the revenue is that the said expenses should be treated as capital expenditure. As a result of the temporary suspension of Boeing project due to the delay at the end of Boeing Co., compensation of Rs. 5,67,13,338/- (over and above compensation given of Rs 16,32,39,485/-) was given towards day-to-day running expenses incurred by the assessee and the same were offered to tax in the return of income being expenses for recurring expenditure. We find that the ld AO had given a categorical finding in para 4.2. of his order , which remain uncontroverted by the ld AR before us, that the business in Boeing Project started from 10/09/2012 falling in Asst Year 2013-14 onwards. Hence all the expenditure and receipts upto 09/09/2012 pertaining to the project would have to be treated as capital in nature. Accordingly, we hold that the receipt of compensation of Rs 5,67,13,338/- should go to reduce the cost of project i.e Capital Work in Progress of the assessee company. Similarly all expenditure incurred by the assessee including Rs 3,75,34,846/- (which was claimed as revenue expenditure by assessee) should also be capitalized to the Capital Work in Progress. This treatment, in our considered opinion, would meet the ends of justice to both assessee as well as for the revenue. Accordingly, the Ground Nos. 2.1. to 2.5. raised by the assessee for the Asst Year 2010-11 are disposed of in the aforesaid manner.

3.3. We find that though the aforesaid tribunal order had elaborately discussed only the compensation received from Boeing Co. towards interest cost and insurance cost, the same would also be equally applicable for the compensation received towards validation support services, warranty, restating etc in view of the observations given hereinbelow.

3.4. We find that the assessee company during the year under consideration received compensation of Rs 10,15,04,000/- towards validation support services, warranty, modification of assets etc, which was credited to profit and loss account by the assessee. The said compensation was received in earlier years towards cost expected to be incurred for modification of fixed assets before they can be put to use. Such cost to be incurred were in the nature of validation support services, warranty, restating etc. The said compensation was credited to ‘Compensation received from Customer pending adjustment against future cost to be incurred and future period cost’ under ‘Other Current Liability’ as at 31.3.2012. The assessee estimated that no further expenditure / cost would be incurred in future in respect of certain assets capitalized during the year under consideration and had therefore credited the said compensation to the profit and loss account during the year under consideration.

3.5. We find that the ld. AO had given the same treatment in respect of compensation received in the sum of Rs 10,15,04,000/- towards validation support services, warranty, restating etc at par with compensation received towards interest cost and insurance cost, by treating the same as income from other sources as envisaged u/s 56(2)(viii) r.w. 145A of the Act. It is not in dispute that the compensation is received by the assessee for validation support services, asset modifications etc proposed by Boeing. Therefore, the compensation received is akin to the character of compensation received by assessee towards interest and insurance cost. Therefore the decision rendered by this tribunal for compensation received towards interest and insurance cost supra would squarely be applicable for compensation received for validation support services, warranty, asset modifications etc also.

3.6. It is pertinent to note that the ld. DR before us had made the very same arguments that were advanced by his predecessor DR before this tribunal in Asst Years 2010-11 to 2012-13 referred to supra.

3.7. In view of the above and respectfully following the judicial precedent relied upon hereinabove, we have no hesitation in holding that the compensation received by the assessee in Asst Year 2013-14 of Rs 7,34,25,476/- towards interest cost ; of Rs 11,46,651/- towards insurance cost and of Rs 10,15,04,000/- towards validation support services, warranty, asset modifications etc would go to reduce the cost of aerospace project of the assessee company. Accordingly the Grounds raised by the assessee for the Asst Year 2013-14 are disposed of in the aforesaid manner.

4. The decision rendered by us for the Asst Year 2013-14 hereinabove shall apply mutatis mutandis for Asst Year 2014-15 also in view of identical fact of compensation received of Rs 1,40,00,000/- towards validation support services, warranty, asset modifications etc.

5. In the result, both the appeals of the assessee are partly allowed.

Order pronounced on 14/07/2022 by way of proper mentioning in the notice board.