ESOP: ITAT allows difference between fair market value at vesting & exercise dates

Lupin Limited Vs DCIT (ITAT Mumbai)

In a recent decision by ITAT Mumbai, Lupin Limited Vs DCIT, the deductibility of ESOP expenses was scrutinized. The article explores the difference between fair market value of equity shares at the vesting and exercise dates, delineating it as allowable expenditure.

The assessee, Lupin Limited, had claimed a substantial deduction for ESOP expenses in its revised income return. However, the Assessing Officer (AO) disallowed the deduction, deeming it notional. The matter was appealed, citing the precedent set by Biocon Ltd’s case (144 ITD 21), where the Special Bench of Bangalore ITAT upheld the deduction.

The Tribunal’s analysis in the present case relied heavily on past rulings, especially Lupin Limited’s own case for AY 2009-10 and AY 2010-11. Notably, the Tribunal’s verdict for AY 2010-11 supported the deduction, following similar lines of reasoning.

The crux of the issue lay in distinguishing between two types of discounts on ESOPs:

1. The first type arises at the time of granting/vesting of ESOP options, amortized over the vesting period.
2. The second type occurs at the actual exercise of option by employees, representing the difference between fair market value at vesting and exercise dates.

The Tribunal acknowledged that both types of discounts are allowable as deductions.

The tribunal emphasized that the deduction for ESOP expenses should be allowable irrespective of whether it is accounted for in the books of account. It upheld that the entries in the books of account are not decisive in computing total income; rather, the deductions should be allowed in accordance with the Income Tax Act provisions.

Ultimately, the Tribunal upheld the allowance of ESOP expenses, aligning with previous decisions and emphasizing the deductibility of the second type of discount, even if not accounted for in the books.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

These appeals of the assessee and the revenue and the Cross Objection (C.O) of the assessee are against the order of the Commissioner of Income Tax (Appeals)-57, Mumbai dated 17.11.2020 [for short ‘the CIT(A)] and against the order of rectification passed by the CIT(A) under section 154 of the Income Tax Act ( (the Act). The CIT(A) has passed the impugned orders against the final order of assessment passed by the Assessing Officer (AO) under section 143(3) r.w.s. 144C(13) of the Act. The issues contended in these appeals and the C.O are common and therefore these appeals are heard together and disposed of through this common order.

2. The issues contended in the above appeals and the C.O are tabulated as under:

Issues	ITA No. 77/M/21	ITA No. 1242/M/21	ITA No. 1241/M/21	CO No. 1/M/22
General				C.O. No.1
Disallowance of depreciation on unverified purchases and other expenses	Ground No.1
Disallowance of depreciation on goodwill on amalgamation	Ground No.2
Transfer Pricing Adjustment on letter of comfort	Ground No.3
Initiation of penalty proceedings u/s 271(1)(c)	Ground No.4
Mark to market loss allowed as deduction under section 37(1)		Ground No.1		C.O. No. 2 to 4
Disallowance of sales promotion expenses		Ground No.2
Expenditure on Employee’s stock option		Ground No.3		C.O. No. 5
Weighted deduction u/s 35(2AB)		Ground No. 4 & 5	Ground No.1 to 3
Pre-commencement expenses		Ground No.6		C.O. No. 6
Deduction u/s 10AA	Additional Ground No.5
Deduction of Education Cess	Additional Ground No.6

3. The assessee vide letter dated 17.08.2023 withdrew the additional ground no.6 and hence the same is dismissed as withdrawn.

4. The assessee is a public limited company engaged in the business of manufacture and sale of pharmaceutical products namely formulations, bulk drugs, etc. The assessee filed a return of income for Assessment Year (AY) 2013-14 on 26.11.2013 declaring a total income of Rs. 12,18,99,68,560/- as per the normal provisions of the Act and a book profits of Rs. 17,28,95,82,575/- under section 115JB of the Act. The assessee filed the revised return of income on 27.11.2014 revising the income under the normal provisions to Rs. 11,81,81,76,880/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. Since the assessee had international transactions a reference was made to the Transfer Pricing Officer (TPO) in order to determine the Arms Length Price (ALP) of the international transactions, the assessee is having with its Associated Enterprises (AE). The TPO made a TP Adjustment of Rs. 41,13,867/- comprising of adjustment on account of corporate guarantee fee of Rs. 28,67,419/- and adjustment on letter of comfort of Rs. 12,46,448/-. The AO besides the TP Adjustments made the following disallowances/additions whereby the income was assessed at Rs. 13,48,27,17,090/- under the normal provisions of the Act:

Sr. No.	Particulars	Amount (Rs.)
1	Depreciation on unverified purchases and other expenses of capital nature	1,07,57,943
2	Disallowance of Mark to market loss	1,18,20,185
3	Disallowance of sales promotion expenses	82,30,32,740
4	Disallowance of expenditure on ESOP	34,65,39,003
5	Disallowance of pre-commencement expenses incurred at Pithampur SEZ-Plant II and Nagpur SEZ Plant	2,89,59,855
6	Disallowance of weighted R&D deduction under section 35(2AB) of the Act	49,94,52,208
7	TP adjustment on account of Corporate Guarantee and Letter of comfort	41,13,867

5. The AO made adjustment to the profits eligible for deduction under section 80IB towards weighted deduction disallowed under section 35(2AB), disallowance of Sales Promotion expenses and disallowance of ESOP expenses to allow additional deduction of Rs.6,01,35,587. Further the AO also did not allow the deduction claimed through a letter during assessment proceedings towards additional depreciation on assets put to use for less than 180 days under section 32(1)(ii) of the Act and deduction towards leave encashment. The AO also made an addition under section 40(a)(v) of the Act towards non-monertary perquisites were made to the tune of Rs.2,95,87,707 accordingly assessing the book profit at Rs. 17,31,91,70,282/- under section 115JB of the Act.

6. Aggrieved the assessee filed further appeal before the CIT(A) partly allowed the appeal by granting relief to the assessee in respect of the following:

➣ Disallowance of Mark to market loss of Rs. 1,18,20,185

➣ Disallowance of sales promotion expenses amounting to Rs. 82,30,32,740

➣ Weighted Deduction under Section 35(2AB) of the Act on Clinical & Analytical Charges of Rs. 49,94,52,208;

➣ Weighted deduction under Section 35(2AB) of the Ac other R&D expenditure of Rs. 8,17,46,000 (through rectification under section 154 of the Act)

➣ Disallowance of ESOP expenditure of Rs. 34,65,39,003 not debited to P&L

➣ Pre-commencement revenue expenses incurred at Pithampur SEZ Plant II and Nagpur SEZ Plant of Rs. 2,89,59,855

➣ Additional depreciation on asset put to use less than 180 days of Rs.7,42,63,633;

➣ Addition of tax on non-monetary perquisites to book profits under section 115JB of the Act of Rs. 2,95,87,707

➣ Transfer Pricing Adjustment on account of Corporate Guarantee Fees of Rs.28,67,419

The CIT(A) upheld the following additions/disallowances

➣ Disallowance for depreciation on unverified purchases and other expenses of Rs.1,07,57,943

➣ Transfer Pricing Adjustment on Letter of Comfort of Rs. 12,46,488

➣ Provision for Leave Encashment of Rs. 10,33,01,542

➣ Depreciation on goodwill on amalgamation of Rs. 21.81 Crore

7. Aggrieved by the order of the CIT(A) both the assessee and the revenue are in the appeal.

I.T.A. No. 77/Mum/2021 – Assessee’s appeal

Disallowance of Depreciation on unverified purchases and other expenses – Ground No.1

8. During the assessment proceedings pertaining to AY 2006-07 to AY 2011­12 under section 143(3) r.w.s. 144C(13) r.w.s.153A and for AY 2012-13 under section 143(3) r.w.s. 144C(13), depreciation was disallowed on certain unverified purchases and expenses which were capitalized in the books of accounts. The AO called on the assessee to furnish the depreciation on the written down value of the disallowed purchases for the year under consideration and accordingly disallowed the depreciation on said unverified purchases for the AY 2013-14 also. The ld. AR submitted that the Co-ordinate Bench of the Tribunal while considering the issue of disallowance of depreciation on unverified expenses capitalized for AY 2009­10 (ITA No.1920/Mum/2020, ITA No. 395/Mum/2021 and C.O. No. 129/Mum/2021 dated 03.02.2023) has deleted the disallowance and has remitted the issue of depreciation on unverified purchases back to the file of the AO for fresh examination. The ld AR further submitted that since for the year under consideration the disallowance is towards the consequential depreciation the issue is covered by the decision of Co-ordinate Bench in assessee’s own case for AY 2009-10 and therefore prayed for a similar direction.

9. The ld. DR relied on the order of the lower authority.

10. We have heard the parties and perused the material on record. In assessee’s case depreciation on unverified purchases were disallowed for AY 2006-07 to AY 2012-13 and the Co-ordinate Bench has given relief to the assessee towards depreciation unverified purchases capitalized and the issue of depreciation on unverified purchases was remitted back to the AO for fresh examination. We notice, that the disallowance made by the AO towards unverified purchases and expenses is the consequential depreciation on the written down value of the assets. The relevant observations of the coordinate bench are extracted below –

Unverified Expenditure

“6.4 In our view, we may leave aside the issue as to whether the said retraction is valid or not, since the assessee is supporting its stand for not disallowing these expenses on merits. In our view, the stand of the assessee, in the facts and circumstances of the case, merits acceptance. First of all, there is no dispute that the amount of Rs.48,89,052/- is not in the nature of commission expenses, i.e., the assessee has admitted that it has booked bogus expenses by way of commission payments only. Secondly, it has furnished the details of materials purchased through these bills, delivery challans etc., to prove receipt of materials. The assessee has also explained the reason as to why these expenses were not added to the total income while computing total income. We notice that the tax authorities have ignored all these aspects on merits, but placed their reliance on the statement made u/s 132(4) of the Act. The provisions of sec.132(4) enables the assessing officer to presume that the admission made in the statement “may be” used in the assessment proceedings. It is well settled proposition of law that it is a rebuttable presumption, meaning thereby, the deponent could show that the admission made by him in the statement was wrong. In the instant case, in our view, the assessee has rebutted the admission by furnishing evidences in support of the expenses. The very same fact that a sum of Rs.9,86,470/- out of the above said expenditure amount of Rs.48,89,052/- represents Capital expenditure (which fact has also been accepted by the AO) would show that there is merit in the submission of the assessee. For booking bogus expenses, it is unlikely that anyone will account for bogus capital expenses. Accordingly, we are of the view that the explanation given by the assessee on this aspect merits acceptance. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and direct the AO to delete the addition of Rs.39,02,582/-. Accordingly, we hold that the consequential disallowance of depreciation on the capital expenditure amount of Rs.9,86,470/- is also not warranted and we direct the AO accordingly.”

Unverified purchases

“7.3 We heard the parties on this issue and perused the record. We notice that the assessee has submitted that it has revised VAT returns under protest on 8th July, 2011, after Sales tax survey, since it would not get input VAT credit on the alleged bogus purchases. It is stated that on the basis or revised sales tax returns, it has agreed to surrender Rs.58.80 crores during the course of search towards bogus purchases in various years, which included Rs.10.00 crores pertaining to the year under consideration. However, it is stated that the assessee has noticed that the most of the vendors were not included in the final list of suspicious dealers published by MVAT authorities in its website. Hence, the assessee has re-revised its VAT returns after verification on 26th June, 2012, i.e., subsequent to the date of search. According to the assessee, the rerevised VAT returns has since been accepted by the VAT authorities. Accordingly, it was submitted that the surrender of income towards alleged bogus purchases was made on the basis of incomplete information and further on the reasons that the assessee was not able to prove the genuineness of purchases at that point of time. 7.4 With regard to the statement given by one of the vendors Shri Naresh Kantilal Shah, which was referred to by the AO, the assessee submitted that it has not made any purchases from the concerns belonging to the above said person during the year under consideration. On legal aspects, the assessee has contended that the addition could not be made merely on the basis of statement given on oath. 7.5 The ld D.R, on the contrary, supported the orders passed by tax authorities on this issue. 7.6 We notice that the assessing officer has entirely placed his reliance on the statement given by the employees and directors of the assessee u/s 132(4) of the Act. Besides the above, the AO has also placed reliance on the statement given by Shri Naresh Kantilal Shah, one of the accommodation entry providers and also the statement given by the Vice President (Taxation). However, we notice that the surrender made by him was not added by the AO. We notice that the assessing officer did not examine the explanations of the assessee as to why it was constrained to make surrender towards alleged bogus purchases. Though there was no specific retraction of the surrender so made, yet we have noticed earlier that the surrender made in the statement recorded u/s 132(4) of the Actcan be rebutted by producing evidences against the surrender. In the instant case, the additional evidences relied upon by the assessee to rebut the surrender are:- (a) Re-revised VAT returns. (b) VAT orders passed by the VAT authorities accepting the rerevised VAT returns, The question of suspicious dealers came to fore only on the reason that these dealers did not deposit VAT tax after issuing accommodation bills. If the assessee could get VAT credit against these bills, then it may be possible to presume that the suppliers are genuine. Under these set of facts, it is claimed by the assessee that the surrender towards bogus purchases was made on the technical reason that the said suppliers have not paid VAT amount, which would disentitle the assessee to claim VAT credit and hence the assessee cannot effectively prove the genuineness of purchases. If the re-revised VAT returns have been accepted by the VAT authorities and the assessee got the credit of VAT amount, it is submitted that the entire foundation on which the surrender was made got demolished. It is also submitted that these suppliers are not included in the list of suspicious dealers by MVAT authorities. 7.7 Under these set of facts, we are of the view that the assessee may be provided with one more opportunity to prove the genuineness of purchases. Accordingly, this issue requires fresh examination at the end of the AO, since the AO has not examined these factual aspects. In order to prove the genuineness the assessee may also furnish documents/details, on sample basis, to show that the relevant goods have been received and used by it. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and restore the same to the file of AO for examining it afresh in the light of discussions made supra.

Therefore respectfully following the above decision, we direct the AO to delete the disallowance of consequential depreciation on unverified expenses and the issue of consequential depreciation on unverified purchases is remitted back to the AO with similar directions. Needless to say that the assessee be given a reasonable opportunity of being heard. This ground of the assessee is partly allowed for statistical purposes.

Disallowance of depreciation on goodwill on amalgamation – Ground No.2

11. There was an amalgamation approved by the Board of Directors and the Hon’ble Bombay High Court of the assessee-company and its wholly owned subsidiaries namely Lupin Pharmacare Ltd., Lupin Herbal Ltd. and Novodign Ltd. w.e.f. 01.04.2009. The amalgamation was accounted in the books of the assessee as per pooling of interest method prescribed by Accounting Standard-14. In terms of the scheme all Assets & Liabilities of the transferor company have been transferred to the assessee-company at their respective book value and all intercompany balances were canceled. Since the transferor companies were wholly owned subsidiaries of the assessee, the shares held by assessee in the transferor company were cancelled and no shares were issued to effect the amalgamation. After giving effect the accounting treatment in terms of the scheme the balance lying in the investment account of the assessee aggregating to Rs. 21.81 crores pertaining to purchase of Novodign Ltd. was shown as goodwill in the accounts of the assessee company. The said amount is arising out the acquisition of shares of the said company by the assessee at a higher price in earlier years. The assessee amortized the goodwill over a period of five years in the books of accounts beginning from AY 2010-11. The assessee claimed the depreciation on the goodwill through a note to the revised return of income. The AO denied the depreciation by relying on the decision of Goetz India Ltd. (284 ITR 323) stating that the assessee has not made the claim by filing the revised return but only through a note. The CIT(A) though admitted the claim of the assessee disallowed the depreciation by relying on the order of his predecessor for AY 2010-11.

12. We have heard both the parties, we noticed that the issue is remitted back to the AO by the Co-ordinate Bench for AY 2010-11 where it is held that

“7.6 We noticed earlier that the assessee had made investment of Rs. 47.39 crores is the subsidiary companies. However, on account of amalgamation of these subsidiary companies, the assessee has received net asset of Rs. 24.82 crores in lieu of above said investment value, Hence, in reality, there was a fall the recovery of investments made by the assessee in these three companies. Under the accounting principles, in the case of amalgamations, the difference between the consideration paid for acquiring a company and the net asset value of assets/liabilities acquired shall be termed as “goodwill”, the pavement made exceeds the value of net assets. On the contrary, if the payment made in less than the net asset value, the gain is termed as “Capital Reserve”. In the instant case, the investment of Rs.47.39 crores made by the assessee is treated as “consideration” paid for acquiring three subsidiary companies. Since the consideration so paid was in excess of the net asset value, the difference amount was treated as “goodwill” as per accounting principles.

7.7 The question is whether the “good will” arising on amalgamation of subsidiary company, which is in the nature of fall in the value of investment. would be of the same nature of the good will arising on acquisition of unrelated concern? Let us take a hypothetical case. Let us assume that a company acquires an “unrelated concern” by way of amalgamation. Let us assume that the consideration paid was Rs.50 crores and the net asset value of assets of acquired was Rs. 40 crores. Since there is excess payment of Rs. 10 crowes, the said excess payment shall be treated as payment towards goodwill. Is this case,

(a) there is cash payment by the company

(b) it in a case of fresh acquisition and not acquisition in lieu of investments already made.

(c) the excess payment was made voluntarily.

(d) such excess payment was a conscious decision, i.e, the buyer should be visualizing some business advantage and hence it was paying higher consideration that the value of net assets.

(e) The business advantage so visualized by the assessee is considered as an intangible asset eligible for depreciation.

7.8 In the instant case, the assessee has acquired its subsidiary companies by taking over their assets and liabilities in lieu of investments made by it. The above said short fall shall be termed as “goodwill” as per accounting principles. The question is whether such kinds of goodwill would fall under the category of business or commercial rights as mentioned in section 32(1)(ii) of the Act, which was interpreted by Hon’ble Supreme Court in the case of Smiffs Securities Ltd (supra). Hence it is imperative for the assessee to show that the good will, being short fall in the value of investments, would also rank at par with the good will which was considered as business or commercial rights as mentioned in sec. 32(1)(ii) of the Act. However, the fact remains that both the tax authorities have not examined this aspect.

7.10 We noticed that the learned CIT(A) has taken support of the sixth proviso to section 32(1) of the Act to reject the claim of depreciation on the good will. However, on a careful perusal of the sixth proviso to sec. 32(1) of the Act, we noticed that the same is applicable only in a situation where the amalgamation takes place in the middle of the year i.e. the said proviso states that the aggregate amount of depreciation claimed by the amalgamating companies and amalgamated company for that year should not exceed eligible amount of depreciation of that year. In the instant case the amalgamation has taken place on 1.4.2009 and not in the middle of the year. Hence the sixth proviso to section 32(1) will not apply to the facts of the present case. Accordingly we set aside the reasoning given by the learned CIT(A) for confirming the disallowance of depreciation of goodwill.

7.11 We noticed earlier that both the tax authorities have not examined the factual aspects relating to the goodwill amount of Rs.21.81 crores and also the depreciation claimed thereon. Hence the assessee also did not get opportunity to put forth its contentions before them. Under these set of facts, we are of the view, that this claim of depreciation on good will requires examination at the end of the AO by duly considering all the relevant factual aspects. Accordingly, we set aside the order passed by the learned CIT(A) on this issue and restore the same to the file of the Assessing Officer for examining it afresh by considering the discussions made supra.”

13. The depreciation on goodwill claimed during the year under consideration is consequential and therefore, the issue is covered by the above decision of the Co­ordinate Bench. Accordingly, we remit the issue back to the AO with similar directions. It is ordered accordingly. This ground is allowed for statistical purposes.

TP Adjustment on letter of comfort (LOC) – Ground No.3

14. The assessee has issued a letter of comfort towards credit facilities sanctioned by ANZ Banking Group Ltd. to assessee’s subsidiaries Multicare Pharmaceuticals Philippines Inc. The TPO treated the said transaction as international transaction and proceeded to bench mark the same. The TPO placed reliance on the decision of the Hon’ble Bombay High Court in the case of Everest Canto (58 com 254 (Bom.)) and the decision of Co-ordinate Bench in the case of Glenmark Pharmaceuticals Ltd. (ITA No. 5031/Mum/2012 dated 13.11.2013) to make an adjustment of 1.5% towards Guarantee Commission. The relevant observations of the TPO are extracted below:

“v) In view of the detailed discussion above, following the recent decision of Hon’ble Bombay High Court in the case of Everest Kanto, and Mumbai ITAT in Glenmark Pharmaceuticals Ltd. in ITA No.5031/Mumbai/2012 dated 13.11.2013 (A.Y. 2008­09), a downward adjustment to the naked quotes of the rates of bank Guarantee has been done in this year, while benchmarking the transaction. It is seen that the bank guarantee rates vary generally between 1% to 3% giving an average of about 2.0%. Accordingly, it would be appropriate to charge 1.5% from the AΕ (average bank guarantee fee charged by bank less 0.50%).”

15. On further appeal the CIT(A) upheld the TP Adjustment by stating that the letter of comfort given by the assessee is nothing but the guarantee given by the assessee and that the assessee is having a financial obligation to the Bank. Therefore, the CIT(A) held that it is an international transaction warranting a TP Adjustment.

16. The ld. AR submitted that the Guarantee Commission in the case of letter of comfort is only warranted in the cases where the letter of comfort is legally binding on the assessee and that there is an obligation by the assessee to the guarantor to make good the losses in case of default by the borrower i.e. the AE. The ld. AR drew our attention to the terms of letter of comfort (page 250 of the PB) to submit that it represents only the intent of the assessee and does not constitute any obligation on the part of the assessee. The ld. AR further submitted that the letter of comfort does not create any legal obligation which the banker may have against the assessee and that the incidental benefit arising to the AE from its passive association with the group does not construe an arrangement which warrants receipt of any monetary consideration. The ld. AR also submitted that the letter of comfort therefore cannot be treated as letter of guarantee warranting a TP Adjustment. The ld. AR relied on the decision of the Co-ordinate Bench in the case of Tata International Ltd. Vs. ACIT (157 com 901).

17. We heard the parties and perused the material on record. The assessee has given a letter of comfort to ANZ Bank towards a loan facility extended by the said bank to the AE of the assessee. The contention of the revenue is that what the assessee gave is not a letter of comfort but is a letter of guarantee and accordingly warrants a TP adjustment. The ld AR drew our attention to the terms mentioned in the letter of comfort to submit that the it does not tantamount to assessee giving any financial guarantee to the Bank towards the loan. The letter of comfort is extracted below in this regard for reference –

18. From the perusal of the terms in the above letter of comfort it is clear that the assessee is giving a comfort to the ANZ bank that the AE would be operated and maintained in such a way to be in a financial position to repay its obligations and not to take any action that would hinder the operations of the AE. The assessee also gives the commitment that assessee’s stake in AE will not go below 51%. Therefore we see no merit in the contention that the assessed has to repay all outstanding to the bank if it reduces its capital below 51% in its AE. Our view is further strengthened by the relevant clauses in the letter of offer given by ANZ to the AE i.e. borrower as extracted by the CIT(A) in his order which is reproduced below –

“I have gone through the above and TPO’s order, It can be held that it would depend on the nature letter of comfort issued to a bank to give a finding that a particular transaction constitute a guarantee or not.

Therefore to held letter of comfort as international transaction/ transaction providing guarantee, it has to be seen whether the letter of comfort cast any additional obligation on the assessee and whether there could be any financial liability on the assessee.

In the present case

The appellant have issued a letter of comfort to ANZ Manila, Philippines. In the Letter of Offer, the following two clauses address the aforementioned issue.

In Clause 1, dealing with the Conditions Precedent, one of the conditions is “Lodgment of other documentary requirements to ANZ’s satisfaction including the issuance and delivery of letter of comfort from Lupin Limited.”

In addition, in Clause 3 detailing Mandatory requirement, it is stipulated that the Borrower shall prepay all outstanding or provide cash cover (as  appropriate) under the facility if the appellant ceases to own at least 51  percent effective share capital in the Borrower.

The above terms in the letter of offer creates an obligation on the borrower that the borrower shall prepay the loan in case the assessee ceases to hold 51% stake in the borrower company. Therefore the financial obligation is cast upon the borrower and not the assessee as has been contended by the revenue. The basic difference is that in the Letter of Comfort, the party issues only a letter that the AE would comply term of financial transaction without any obligation to indemnify whereas in case of corporate guarantee, the party issuing guarantee is under obligation to the lender. Considering the terms agreed in the letter of comfort and the terms of the letter of offer we are inclined to hold that what the assessee has given to ANZ towards loan facility granted to its AE is only a letter of comfort and not a guarantee. We notice that Rule 10TA of Safe Harbour Rules for International Transactions defines “corporate guarantee” as explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long-term borrowing and does not include letter of comfort, implicit corporate guarantee, performance guarantee or any other guarantee of similar nature. In the facts and circumstances of the present case, we are of the considered view that the letter of comfort given by the assessee cannot be treated as letter of guarantee warranting any TP adjustment. Accordingly the adjustment made by the TPO is hereby deleted. This ground is allowed in favour of the assessee.

19. Ground No.4 raised by the assessee is regarding initiation of penalty proceedings which is consequential not warranting any separate adjudication.

Allowability of deduction under setion 10AA of 100% of profits derived from Export Oriented Unit before considering the additions/deletions

20. The assessee through additional ground is contending that the deduction under section 10AA of the Act with respect to Pithampur SEZ Unit should be allowed on the commercial profit and not on the profit after the deductions/additions. In support of the admission of this additional ground, the learned A.R. submitted that it involved only adjudication of legal issue and no fresh facts were required to be examined. The learned Departmental Representative opposed the admission of additional ground. Keeping into consideration the entire conspectus of the facts and circumstances of the case and the additional ground raised before us we are convinced that its adjudication does not require any fresh investigation of facts and involves only legal issue. Respectfully following the judgement of the Hon’ble Supreme Court in the case of National Thermal Power Company Ltd. Vs. CIT [(1998) 229 ITR 383 (SC)] we admit this additional ground for disposal on merits.

21. The ld AR submitted that a similar issue was contended before the coordinate bench for AY 2009-10 where the Tribunal has remitted the issue back to the AO for examination. The ld AR however submitted that the coordinate bench in the case of Reliance Industries Ltd. [(ITA No. 7299 & 136/Mum/2017) dated 10 November 2020] where it has been held that deduction under Section 10AA/10B should be computed considering only the commercial profits derived by SEZ/EOU units from exports and not net profit after adjusting various additions/disallowances under Income Tax Act. Accordingly the ld AR prayed that the issue may be decided by the bench for the year under consideration.

22. The ld DR relied on the order of the lower authorities.

23. We heard the parties and perused the material on record. We notice that the coordinate bench in assessee’s own case for AY 2009-10 has considered a similar issue and held that –

12 The assessee has raised an additional ground with regard to the claim for deduction u/s 10B of the Act. In this ground, it is contended that the deduction u/s 10B of the Act should be computed with reference to Profits and gains derived by 100% Export Oriented Units (Pril, Oral and Goa) from M/s. Lupin Limited 21 exports without deducting allowances under the Income tax Act, i.e., the claim of the assessee is that the deduction should be allowed on commercial profits. In this regard, the assessee has placed its reliance on the decision rendered by co-ordinate bench of Tribunal in the case of Reliance Industries Ltd (ITA No.7299 & 136/Mum/2017 dated 10th November, 2020). The Ld D.R submitted that the above said issue is a new ground taken by the assessee before the Tribunal. Inviting our attention to sec.10B(6) of the Act, the ld D.R submitted that this sub-section contemplates that the depreciation and other allowances should be allowed and even if the assessee did not claim deduction u/s 10B in any of the year, then the depreciation and other allowances are deemed to have been allowed. Accordingly, the Ld D.R submitted that the intention of the legislature is that the depreciation and other allowances are to be deducted from the profits and the deduction shall be allowed thereon. Accordingly, the ld D.R submitted that this issue may be restored to the file of AO for examining it.

12.1 We heard the parties on this issue and perused the record. Since the assessee is raising an altogether new issue, which has not been examined by the tax authorities, the ld D.R submitted that this claim of the assessee requires examination at the end of AO. We agree with the submission made by Ld D.R. Accordingly, we restore this issue to the file of AO for examining this claim of the assessee.

24. For the year under consideration also the assessee has not raised this issue before the lower authorities and therefore respectfully following the above decision of the Tribunal we remit the issue back to AO for examination with a direction to decide keeping in mind the decision of coordinate bench in the case of Reliance Industries Ltd (supra) and decide in accordance with law. This ground is allowed for statistical purposes.

I.T.A. No. 1242/Mum/2021 – Revenue’s appeal

Allowability of mark to market (MTM) loss under section 37(1) – Ground No.1

25. For the year under consideration the assessee had provided for loss arising on the outstanding derivatives contracts in respect of foreign exchange receivables and derivatives contract which were valued at the year end. Accordingly, the assessee provided for MTM loss of Rs. 1,18,20,185/-. The AO disallowed the expenditure by placing reliance on the CBDT Instruction No. 3/2010 dated 23.03.2010. The AO also rejected the assessee’s alternate plea that since section 43(5) is not applicable the MTM losses should be allowed under section 28 or 37(1) of the Act. Aggrieved the assessee filed appeal before the CIT(A). The CIT(A) deleted the disallowance by placing reliance on the decision of the Hon’ble Bombay High Court in assessee’s own case for AY 2008-09 and the order of his predecessor for AY 2009-10. Against the order of the CIT(A) the department is in appeal before the Tribunal.

26. The ld DR placed reliance in the order of the AO. The ld. AR brought to our attention that this is a recurring issue in assessee’s case and that the Co-ordinate Bench while considering the appeal for AY 2012-13 has held that

“35.1 We notice that an identical issue has been examined by the Tribunal in the assessee’s own case in AV 2000-10. The relevant discussions made in that year are extracted below:

13. We shall now take up the appeal filed by the revenue. The first issue contested by the revenue relates to the disallowance of mark to market loss of Rs.3,39,71,181/- made by the AO and deleted by Id CITIA). The assessee is supporting the decision rendered by Ld. CIT(A) on this issue in the cross objections filed by it. The assessee had revalued the derivative contracts outstanding as at the yearend in respect of foreign exchange receivables. The same resulted in a loss of Rs.3.39 crores and it was claimed by the assessee has deduction. The AO disallowed the claim by placing reliance on CBDT Instruction no.3/2010 and holding it as notional loss. The Ld CIT(A) noticed that an identical disallowance made by the AO in AY 2008-09 has been deleted by the Tribunal in ITA No.7513 & 7274/Mum/2014 and the same has been affirmed by the Hon’ble Bombay High Court in ITA No. 1532 of 2017 dated 2nd April, 2019. Accordingly, the Ld CIT(A) deleted this disallowance. The revenue is aggrieved.

13.1 We heard the parties on this issue and perused the record. It is the submission of the assessee that the forward contracts have been entered to cover future export receivables. The break-up details of above said loss are given as under by the assessee:

M to M Loss in relation to effective portion of Forward Contract outstanding on 31.3.09	42,53,527
M to M Loss in relation to ineffective portion of Option contract outstanding on 31.3.09	39,97,341
M to M Loss in relation to derivative asset w/off relating to Option Contract	2,66,20,000
	3,48,70,868
Less: Reversal of M to M Loss in relation to Ineffective portion of Option contract	8,99,687

13.2 The Ld A.R submitted that an identical issue has been examined by the Tribunal in the assessee’s own case in AY 2008-09 and it has been decided in favour of the assessee following the decision rendered by Hon’ble jurisdictional Bombay High Court in the case of CIT vs. M/s D Chetan & Co (ITA No.278 of 2014 dated 01-10-2016)( [2016] 75 taxmann.com 300 (Bombay)). We also notice that the decision rendered by the Tribunal in the assessee’s own case has since been upheld by Hon’ble Bombay High Court, vide its order dated 2nd April, 2019 in ITA No. 1532 of 2017. In the case of M/s D Chetan & Co. (supra), the Hon’ble Bombay High Court held as under:-

“5. Being aggrieved, the Revenue preferred an appeal to the Tribunal. The impugned order of the Tribunal upheld the finding of the CIT (Appeals) that the loss incurred by the Respondent Assessee was a revenue loss and not connected with any speculation activities. The Tribunal found that the transaction of forward contract had been entered into for the purpose of hedging in the course of its normal business activities of import and export of diamonds. Thus, the Revenue’s appeal was dismissed by the impugned order of the Tribunal.

6. Mr. Malhotra, learned Counsel appearing for the Revenue submits that this appeal had to be admitted as the impugned order has ignored its order in the case of S. Vinodkumar Diamonds (P.) Ltd. v. Addl. CIT [2013] 59 SOT 124/35 taxmann.com 337 (Mum. – Trib.) rendered on 3 May 2013 which on similar facts is in favour of the Revenue. He further submits that the impugned order of the Tribunal is suspect because it accepts the Respondent assessee’s claim without calling upon it to prove that the same was not speculative. Lastly, he sought to place reliance upon Accounting Standard-11 to claim that such a loss is not allowable thereunder.

7. The impugned order of the Tribunal has, while upholding the finding of the CIT (Appeals), independently come to the conclusion that the transaction entered into by the Respondent assessee is not in the nature of speculative activities. Further the hedging transactions were entered into so as to cover variation in foreign exchange rate which would impact its business of import and export of diamonds. These concurrent finding of facts are not shown to be perverse in any manner. In fact, the Assessing Officer also in the Assessment Order does not find that the transaction entered into by the Respondent assessee was speculative in nature. It further holds that at no point of time did Revenue challenge the assertion of the Respondent assessee that the activity of entering into forward contract was in the regular course of its business only to safeguard against the loss on account of foreign exchange variation. Even before the Tribunal, we find that there was no submission recorded on behalf of the Revenue that the Respondent assessee should be called upon to explain the nature of its transactions. Thus, the submission now being made is without any foundation as the stand of the assessee on facts was never disputed. So far as the reliance on Accounting Standard-11 is concerned, it would not by itself determine whether the activity was a part of the Respondent-assessee’s regular business transaction or it was a speculative transaction. On present facts, it was never the Revenue’s contention that the transaction was speculative but only disallowed on the ground that it was notional. Lastly, the reliance placed on the decision in S. Vinodkumar Diamonds (P.) Ltd. (supra) in the Revenue’s favour would not by itself govern the issues arising herein. This is so as every decision is rendered in the context of the facts which arise before the authority for adjudication. Mere conclusion in favour of the Revenue in another case by itself would not entitle a party to have an identical relief in this case. In fact, if the Revenue was of the view that the facts in S. Vinodkumar (supra) are identical/similar to the present facts, then reliance would have been placed by the Revenue upon it at the hearing before the Tribunal. The impugned order does not indicate any such reliance. It appears that in S. Vinodkumar Diamonds (P.) Ltd. (supra), the Tribunal held the forward contract on facts before it to be speculative in nature in view of Section 43(5) of the Act. However, it appears that the decision of this court in CIT v. Badridas Gauridu (P.) Ltd. [2003] 261 ITR 256/[2004] 134 Taxman 376 (Mum.) was not brought to the notice of the Tribunal when it rendered its decision in S. Vinodkumar Diamonds (P.) Ltd. (supra). In the above case, this court has held that forward contract in foreign exchange when incidental to carrying on business of cotton exporter and done to cover up losses on account of differences in foreign exchange valuations, would not be speculative activity but a business activity.

8. In the above view, the question of law, as formulated by the Revenue, does not give rise to any substantial of law. Thus, not entertained.”

The Ld CIT(A) has followed the decision rendered by Hon’ble jurisdictional High Court and has decided this issue in favour of the assessee.

13.3 We notice from the break-up details of the claim extracted above, the M to M loss on “forward contracts” was Rs.42.53 lakhs. The other two items relate to “ineffective Option Contracts” and “Derivative asset w/off relating to option contracts”. The nature of these items is not clear and we notice that no tax authority has examined these items. If these transactions have been entered in the course of carrying on of regular business activities and the underlying assets are trading items, the loss arising on their revaluation at the year end is allowable as deduction. It is to be seen that the underlying assets having foreign currency exposure is also revalued as at the year end Accordingly, for the limited purpose of verifying these factual aspects, we restore this issue to the file of the AO for examining this issue in the light of principles laid down by Hon’ble jurisdictional Bombay High Court in the case of D Chetan & Co (supra).”

35.2 Following the above said decision, we restore this issue to the file of AO with similar directions.”

27. The issue for the year under consideration being identical, we restore the issue to the AO with similar directions. The ground raised by the Revenue is disposed of accordingly.

28. Ground No. 2 in revenue’s appeal pertains to the disallowance of sales promotion expenses. The ld AR fairly conceded that the issue is covered against the assessee. The ld DR supported the order of the AO. Considering the facts and circumstances of the case, the Ground raised by the revenue is allowed and the disallowance made by the AO is hereby confirmed.

Allowability of ESOP expenses – Ground No.3

29. The assessee had claimed a deduction of Rs.34,65,39,003 as ESOP expenses in the revised return of income. The AO disallowed the same holding the said expenses to be notional. The CIT(A) allowed the deduction by placing reliance on the decision of the Special Bench in the case of Biocon Ltd (2104) (144 ITD 21)(Bang)(SB).

30. We heard the parties. We notice that the issue is covered by the decision of the coordinate bench in assessee’s own case for AY 2009-10 and AY 2010-11. The relevant findings of the Tribunal for AY 2010-11 is extracted below –

12.1 We noticed that an identical claim made by the assessee was disallowed in A.Y. 2009-10 by the AO. This issue was examined in detail by the Tribunal in ITA No. 395/Mum/2021 read with order passed in M.A. No. 193/Mum/2023 arising out of ITA No. 395/Mum/2021 relating to A.Y. 2009- 10. The final decision rendered by the Tribunal is extracted below by culling out relevant observations from the main order and the order passed in the Miscellaneous Application filed by the assessee:-From Main Order:-

“15.1 The Ld CIT(A) allowed the claim of the assessee following the decision rendered by Special bench of Bangalore ITAT in the case of Biocon Ltd vs. DCIT (144 ITD 21). It is pertinent to mention that the decision rendered by the Special bench has since been upheld by the Hon’ble Karnataka High Court in 430 ITR 151.

15.2 The Ld D.R submitted that the Circular no. 9 of 2007 issued by CBDT has not been considered by the Special bench or by the Hon’ble High Court of Karnataka.

15.3 We heard Ld A.R and perused the record. It is well settled proposition that the Circular issued by CBDT is binding only on tax authorities and it will not bind on the Courts. The Hon’ble Karnataka High Court has dealt with this issue as under in the case of Biocon Ltd (supra) as under:-

“9. In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means at the end of first year, the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date. On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPs is not a contingent liability but is an ascertained liability.

10. From perusal of section 37(1), which has been referred to supra, it is evident that an assessee is entitled to claim deduction under the aforesaid provision if the expenditure has been incurred. The expression ‘expenditure’ will also include a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which it is issued and the market value of the shares would also be expenditure incurred for the purposes of section 37(1) of the Act. The primary object of the aforesaid exercise is not to waste capital but to earn profits by securing consistent services of the employees and therefore, the same cannot be construed as short receipt of capital. The tribunal therefore, in paragraphs 9.2.7 and 9.2.8 has rightly held that incurring of the expenditure by the assessee entitles him for deduction under section 37(1) of the Act subject to fulfillment of the condition.

11. The deduction of discount on ESOP over the vesting period is in accordance with the accounting in the books of account, which has been prepared in accordance with Securities and Exchange Board of India

(Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.”

Continued in MA order:-

“15.4 We notice that the Special bench has recognised that the discount on ESOP arises on two occasions, viz.,

(a) First type of discount arises at the time of granting and/or vesting of ESOP options and it represents the difference between fair market value on the date of granting/vesting date and the price at which shares are offered to the employees. This discount is usually amortised over the vesting period. The employee need not exercise option at the time of vesting itself.

(b) The second type of discount arises at the time of “actual exercise of option” by the employees and it represents the difference between the fair market value of the equity shares on the date of vesting of option and the date of exercise of option.

In the instant case, the amount of Rs.5,74,85,066/- claimed by the assessee represents the second type of discount mentioned in (b) above, i.e., the additional discount arising at the time when the employees actually exercise option. It is the submission of the assessee that the first type of discount did not arise in the instant case, since there was no difference between market price of equity shares and the price at which the shares were offered to the assessee. As per the decision rendered by the Special bench of Bangalore ITAT in the case of Biocon Ltd (supra), the second type of discount arising at the time of actual exercise of option by the employees is also allowable as deduction. This is clear from the discussions made by the Special bench in paragraph 11.1.6 of its order, more particularly, the discussion made in respect of “Situation II” explained by way of illustration by the Tribunal. Accordingly, the above said claim of the assessee is allowable as deduction.

15.5We noticed that the assessee has claimed this amount as deduction before the AO during the course of assessment proceedings and it is the case of the AO that the assessee has not accounted for the same in the books of account. It is the submission of the assessee that the first type of discount is required to be accounted in the books of account and the second type of discount is not required to be accounted. We notice that the requirement of accounting second type of discount has been examined by the Special bench in paragraphs 11.2.8 and 11.2.9 of its order. We notice that the Special bench has stated that the SEBI guidelines did not discuss about the accounting of second type of discount. Accordingly, the Special bench held that the deduction of additional discount has to be allowed as per taxation principles. For the sake of convenience, we extract below paragraphs 11.2.8, 11.2.9 and 11.3 of the order passed by the Special bench:-

“11.2.8. The plea now raised before us by the ld. AR, relying on the case of Challapalli Sugars Ltd.’s case, was also taken up before the Hon’ble Supreme Court in the case of Tuticorin Alkalis (supra). Dealing with the same, the Hon’ble Supreme Court held that : “The question in Challapalli Sugars Ltd.’s case [1975] 98 ITR 167 (SC) was about computation of depreciation and development rebate under the Indian Income-tax Act, 1922. In order to calculate depreciation and development rebate it was necessary to find out “the actual cost” of the plant and machinery purchased by the company. This court held that “cost” is a word of wider connotation than “price”. There was a difference between the price of a machinery and its cost. This court thereafter pointed out that the expression “actual cost” had not been defined in the Act. It was, therefore, necessary to find out the commercial sense of the phrase………..  The judgment in Challapalli’s case [1975] 98 ITR 167 (SC), goes to show that the court was not in any way departing from legal principles because of any opinion expressed by the Institute of Chartered Accountants.” From the above observations there is not even an iota of doubt in our minds that there can be no question of following the accounting principle or Guidance notes etc. in the matter of determination of total income.

11.2.9. The trump card of the ld. AR to bolster his submission for assigning the status of binding force to the SEBI Guidelines is the order in the case of SSI Limited (supra) which came to be affirmed by the Hon’ble Madras High Court in PVP Ventures (supra). We have noticed above that the said case dealt a situation falling within one of the three years of the vesting period, in which it was held that one third of the total amount of discount computed on the basis of the market price of the shares at the time of grant of option, is deductible. It is evident from the SEBI Guidelines that these deal with the deductibility of discount in the hands of company during the years of vesting period. These Guidelines are silent on the position emanating from variation in the market price of the shares at the time of exercise of option by the employees vis-à-vis the market price at the time of grant of option. In other words, the SEBI Guidelines prescribe accounting treatment only in respect of the period of vesting of the options and the situation arising out of unvested options or vested options lapsing. The very reference by the Chennai Bench of the Tribunal in SSI Limited (supra) to the SEBI Guidelines is indicative of the fact that it dealt with a year during which the options were vesting with the employees and the company claimed discount during the vesting period. The Hon’ble Madras High Court in the case of PVP Ventures (supra) has upheld the view taken by the Chennai Bench in the case of SSI Limited (supra). The granting of the binding force to the SEBI Guidelines by the Hon’ble Madras High Court should be viewed in the context of the issue before it, which was about the deductibility of discount during one of the vesting years. In the earlier part of this order, we have held that the deductibility of discount during the vesting period, as prescribed under the SEBI Guidelines, matches with the treatment under the mercantile system of accounting. To that extent, we also hold that the SEBI guidelines are applicable in the matter of deduction of discount. Neither there was any issue before the Hon’ble Madras High Court nor it dealt with a situation in which the market price of the shares at the time of exercise of option is more or less than the market price at the time of grant of option. It is a situation which has also not been dealt withby the Guidelines. Accordingly, the afore noted taxation principle of granting deduction for the additional discount and reversing deduction for the short amount of discount at the time of exercise of option, needs to be scrupulously followed

11.3. We, therefore, sum up the position that the discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of shares at the time of grant of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option. No accounting principle can be determinative in the matter of computation of total income under the Act. The question before the special bench is thus answered in affirmative by holding that discount on issue of Employee Stock Options is allowable as deduction in computing the income under the head `Profits and gains of business or profession’.”

We notice that the assessee has also paid “fringe benefit tax” on the second type of discount (referred supra). It is well settled principle of taxation that the entries made or otherwise in the books of account are not relevant for computing total income, i.e., the total income has to be computed as per the provisions of Income tax Act. If the deduction is otherwise allowable as deduction in computing total income, the same is allowable irrespective of the fact whether the same is accounted in the books of account or not. We notice that this principle has been applied by the Special bench with regard to second type of discount. Accordingly, we are of the view that the Ld CIT(A) was justified in allowing the deduction of Rs.5,74,85,065/- claimed by the assessee. Accordingly, we uphold the order passed by Ld CIT(A) on this issue.”

12.2 Since the facts are identical in this year also, following the above said order passed by the Tribunal, we hold that the learned CIT(A) was justified in allowing the ESOP expenditure claimed by the assessee. Accordingly we uphold the order passed by the learned CIT(A) on this issue.

31. Respectfully following the above decision, we see no infirmity in the order of the CIT(A) in allowing the deduction towards ESOP expenses claimed by the assessee.

Weighted deduction under section 35(2AB) – Ground No.4 & 5

32. During the year under consideration the assessee has incurred expenditure of Rs. 44,37,02,233/- on clinical trials, bioequivalence studies etc. outside in-house approved R&D facilities. In the return of income the assessee has claimed weighted deduction under section 35(2AB) of the Act on the aforesaid expenditure. The R&D facilities of the assessee were accorded approval regularly on year on year basis and the copy of the approval was submitted by the assessee before the lower authorities. The assessee had also claimed while filing the return of income R&D Expenditure of Rs. 8,17,46,000/- which was not approved by DSIR in Form 3CL. The AO held that the expenditure incurred outside the R&D Centre and the expenditure which is not approved by the DSIR are not eligible for weighted deduction and accordingly disallowed both the above referred claims. The CIT(A) by relying on the decision of assessee’s own case for AY 2010-11 and AY 2011-12 allowed the weighted deduction under section 35(2AB). The revenue is in appeal against the order of the CIT(A).

33. The ld. AR submitted that the Co-ordinate Bench in assessee’s own case for AY 2010-11 while considering a similar issue has held that –

11.3 We noticed that the AO had made identical disallowance in Asst. Year 2009-10. The Coordinate Bench has examined the same in the assessee’s own case in A.Y. 2009­10 and decided in favour of the assessee by following the decision rendered by Hon’ble Gujarat High Court in the case of Cadila Pharmaceuticals Ltd. (supra). The observations made by the coordinate bench in AY 2009-10 are extracted below:-

“14.3. We heard the rival contentions and perused the record. In our view, following questions arises on this issue in respect of the claim u/s 35(2AB) of the Act made by the assessee:-

(a) Whether expenditure incurred on clinical trials, bioequivalence studies outside the in-house facility is eligible for weighted deduction u/s 35(2AB) of the Act?

(b) Whether the weighted deduction u/s 35(2AB) could be allowed during the year under consideration, even if the expenditure has not been certified by DSIR in Form no.3CL?

(c) Whether expenditure incurred prior to the date of approval could be allowed as deduction?

(d) Whether the deduction u/s 35(2AB) could be allowed in the absence of approval of scientific research in-house facility by DSIR?

14.4 With regard to the first question, conflicting views have been expressed by different benches of the Tribunal. However, Hon’ble Gujarat High Court has considered this issue as under in its decision reported in the case of Cadila Healthcare Ltd (2013)(31 taxmann.com 300)(Guj) as under:-

“11.Revenue has also suggested following question :

“D. Whether the Appellate Tribunal has substantially erred in holding that the expenses incurred outside the approved R&D facility would also get weighted deduction based on the word under “on in house” interpreting contradictorily to the finding of coordinate bench in Concept Pharmaceuticals Ltd. v. ACIT (ITAT, Mum) reported at 43 SOT 423?”

12. We may record that question ‘E’ in the appeal memo is an additional question which has an element of above noted question. We have, therefore, not separately reproduced the same in this order. The issue is whether the assessee who has incurred expenditure for scientific research, which was not in the in-house facility, could be covered for deduction under section 35(2AB) of the Income Tax Act, 1961.

13. More or less, facts are not in dispute. The assessee carried out scientific research in its facility approved by the prescribed authority. It incurred various expenditure including on clinical trials for developing its pharmaceutical products. These clinical trials were conducted outside the approved laboratory facility. The Revenue holds a belief that such expenditure not having been incurred in the approved facility cannot form part of the deduction provided under section 35(2AB) of the Act. The Tribunal observed that the term ‘in-house’ used in section 35(2AB) of the Act must be viewed in the context of which it has been used. If by utilizing the staff or resources of an organization, research is conducted within the organization rather than through utilization of external use of resources or staff, it can be stated to be an in-house research. On such basis, the Tribunal rejected the Revenue’s contention that merely because an expenditure which was not incurred in the in-house facility cannot be discarded for the weighted deduction under section 35(2AB) of the Act. Learned counsel for the Revenue, however, strongly relied on the certificate issued by the Prescribed Authority, which segregated the expenditure in two parts, that incurred in in-house facility and that incurred outside.

14. In our opinion, the Tribunal committed no error. Section 35(2AB) of the Act provides for deduction to a company engaged in business of biotechnology or the business of manufacture or production of any article or thing notified by the Board towards expenditure of scientific research development facility approved by the prescribed authority. Such deduction at the relevant time was one-and-a-half times expenditure which has now been increased to twice the eligible expenditure. We may notice that explanation to section 35(2AB)(1) which was introduced by the Finance Act 2001 with effect from 1.4.2002 reads as under:

“Explanation – For the purposes of this clause, “expenditure on scientific research” in relation to drugs and pharmaceuticals, shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under any Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970 (39 of 1970).”

15. Such explanation thus provides that for the purpose of said clause, i.e. clause (1) of section 35(2AB), expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under the Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970.

16. The whole idea thus appears to be to give encouragement to scientific research. By the very nature of things, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority. Before a pharmaceutical drug could be put in the market, the regulatory authorities would insist on strict tests and research on all possible aspects, such as possible reactions, effect of the drug and so on. Extensive clinical trials, therefore, would be an intrinsic part of development of any such new pharmaceutical drug. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company. If we give such restricted meaning to the term expenditure incurred on in-house research and development facility, we would on one hand be completely diluting the deduction envisaged under sub-section (2AB) of section 35 and on the other, making the explanation noted above quite meaningless. We have noticed that for the purpose of the said clause in relation to drug and pharmaceuticals, the expenditure on scientific research has to include the expenditure incurred on clinical trials in obtaining approvals from any regulatory authority or in filing an application for grant of patent. The activities of obtaining approval of the authority and filing of an application for patent necessarily shall have to be outside the in-house research facility. Thus the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless. For the scientific research in relation to drugs and pharmaceuticals made for its own peculiar requirements, the Legislature appears to have added such an explanation.

17. In the case Dy. CIT v. Mastek Ltd. [2012] 210 Taxman 432/25 com 133 (Guj.) and connected matters, a Division Bench of this Court had touched on the aspect of what can be termed as scientific research. In the context, certain observations made by the Bench may be of some relevance.

“25. It can thus be seen that the term scientific research in the context of the deduction allowable under section 35(1) of the Act would include wide variety of activities. It can also be appreciated that every scientific research need not necessarily result into the ultimate goal with which it may have been undertaken. Often times in the field of research and invention, the efforts undertaken may or may not yield fruitful results. What is to be ascertained is whether any scientific research was undertaken and not whether such scientific research resulted into the ultimate aim for which such research was undertaken. It can be easily envisaged that the scientific research undertaken often times would completely fail to achieve desired results. That by itself does not mean that no scientific research was undertaken. What the Legislature desired to encourage by granting deduction under section 35(1) of the Act was a scientific research and not necessarily only the successful scientific research undertaken by an assessee.”

18. We are, therefore, of the opinion that the Tribunal committed no error. Merely because the prescribed authority segregated the expenditure into two parts, namely, those incurred within the in-house facility and those can were incurred outside, in our opinion, by itself would not be sufficient to deny the benefit to the assessee under section 35(2AB) of the Act. It is not as if that the said authority was addressing the issue for deduction under section 35(2AB) of the Act in relation to the question on hand. The certificate issued was only for the purpose of listing the total expenditure under the Rules. Therefore, no question of law arises.”

It can be noticed that the Hon’ble Gujarat High Court, after making extensive discussion on the issue and after holding that the Tribunal has committed no error, refused to admit the issue by observing no question of law arises. The revenue has challenged before Hon’ble Supreme Court the decision of Hon’ble Gujarat High Court in holding that no question of law arises. The Hon’ble Apex Court, vide its order dated 14th October, 2015 passed in SLP (c) No.770/2015 has directed the Hon’ble Gujarat High Court to admit the question of law and hear the revenue. However, no other order, if any, passed by Hon’ble Gujarat High Court was brought to our notice on the issue under our consideration in pursuance of the directions given by Hon’ble Supreme Court. In this connection, we may gainfully refer to the decision rendered by co-ordinate bench of Hyderabad in the case of DCIT vs. Aurobindo Pharma Limited (supra), wherein the effect of direction given by Hon’ble Supreme Court was examined and it was observed as under:-

“……As seen from the order of the Supreme Court in Special Leave to Appeal (C) No.770/2015, dated 13.10.2015, the grievance of Revenue with reference to non-framing of three questions were considered by the Hon’ble Supreme Court as those three questions are considered to ‘substantial question of law’ and referred to the Hon’ble High Court to hear the aforesaid three questions of law. However, the judgement already passed by the Gujarat High Court has not been set-aside….”

The Hyderabad bench of Tribunal also distinguished the decision rendered by the Mumbai bench of Tribunal in the case of Concept Pharmaceuticals Ltd (supra) by observing as under:-

“We have considered rival contentions and perused the case law placed on record. In the decision of Concept Pharmaceuticals ltd (supra) the Coordinate bench did not allow the expenditure spent outside the R & D unit but the Bench has not considered the explanation introduced with reference to ‘Clinical Trials’. By very nature, the Clinical Trials cannot alone be done within research facility as they require cooperation from the Medical Doctors, Hospitals, Volunteers and patients, therefore such expenditure has to be necessarily spent outside the facility, but for the purpose of ‘in-house’ research. This issue was examined by the Coordinate Bench which was subject matter of appeal before the Gujarat High Court and Gujarat High Court has approved the same….. ”

Accordingly, following the decision of Hon’ble Gujarat High Court, we hold that the amount spent by the assessee on clinical trials outside the approved in-house facility is eligible for weighted deduction u/s 35(2AB) of the Act.

Since the facts are identical in this year also and since the decision rendered by Ld CIT(A) on this issue is in accordance

34. The facts for the year under consideration being similar respectfully following the above decision we uphold the decision of the CIT(A) in allowing weighted deduction towards clinical trial expenses outside the in-house facility. This ground of the revenue is dismissed.

Pre-commencement Expenses – Ground No.6

35. The assessee while filing the revised return of income claimed pre­production commencement revenue expenditure pertaining to Pithampur SEZ Plant-II and Nagpur SEZ to the tune of Rs. 2,89,59,855/-. The AO by following the decision of his predecessor disallowed the said expenditure. The CIT(A) gave relief to the assessee by directing the AO to allow the expenditure as revenue expenditure. The ld. AR submitted that the issue is covered by the decision of the Co-ordinate Bench in assessee’s own case for AY 2010-11 and accordingly prayed that the CIT(A) decision be upheld.

36. We have heard the parties and perused the material on record. The Co­ordinate Bench while considering issue for AY 2010-11 has held that

“14.3 We notice that the Ld CIT(A) has accepted the fact that the business has been set up and hence revenue expenses incurred in that plant are allowable as deduction. He also accepted the alternative contention of the assessee that the Pithampur SEZ plant is extension of existing business and accordingly directed the AO to allow the exhibit batch expenditure as revenue expenditure. However, he rejected the claim of depreciation. The revenue is aggrieved.

14.4 The uncontroverted fact is that the business of the assessee in Pithampur SEZ has been set up and further it is an extension of existing business. We notice that the Ld CIT(A) has allowed the claim following the legal principles pronounced by the Courts. Hence, we do not find any infirmity in the decision rendered by Ld CIT(A) on this issue.”

37. Respectfully following the above decision, we see no reason to interfere with the decision of the CIT(A). This ground of the revenue is dismissed.

I.T.A. No. 1242/Mum/2021- Revenue’s Appeal

38. Ground No.1 to 3 in the appeal of the revenue pertain to weighted deduction allowed by the CIT(A) towards the amount not allowed by DSIR in Form 3CL to the tune of Rs.817.46 lakhs. The CIT(A) allowed the claim through a rectification order under section 154 of the Act. In this regard we notice that the coordinate bench in assessee’s own case has considered a similar issue where it has been held that –

14.5 The next question is Whether the weighted deduction u/s 35(2AB) could be allowed during the year under consideration, even if the expenditure has not been certified by DSIR in Form no.3CL?. The ld D.R placed her reliance on the decision rendered by Hon’ble Karnataka High Court in the case of Tejas Network Ltd (2015)(60 taxmann.com 309)(Kar), wherein it was held that the AO cannot sit in judgment over the report submitted by prescribed authority. Accordingly, the Ld D.R submitted that the AO has to necessarily follow the report given by the prescribed authority. The Ld D.R submitted that, in the instant case, the DSIR (Prescribed authority) has not certified the expenses incurred outside the in-house facility and the AO could not sit in judgment over the said report. Accordingly, the Ld D.R submitted that the unapproved expenses cannot be allowed deduction u/s 35(2AB) of the Act.

14.6 The next question is whether expenditure incurred prior to the date of approval could be allowed as deduction? Both these questions are answered together.

14.7 The legal sanctity of Form no.3CL was examined by the Pune bench of ITAT in the case of Cummins Ltd vs. DCIT (ITA No.309/Pun/2014 dated 15.5.2018 relating to AY 2009-10). It was held as under:-

“45. The issue which is raised in the present appeal is that whether where the facility has been recognized and necessary certification is issued by the prescribed authority, the assessee can avail the deduction in respect of expenditure incurred on in-house R&D facility, for which the adjudicating authority is the Assessing Officer and whether the prescribed authority is to approve expenditure in form No. 3CL from year to year. Looking into the provisions of rules, it stipulates the filing of audit report before the prescribed authority by the persons availing the deduction under section 35(2AB) of the Act but the provisions of the Act do not prescribe any methodology of approval to be granted by the prescribed authority vis-à-vis expenditure from year to year. The amendment brought in by the IT (Tenth Amendment) Rules w.e.f. 1-7-2016, wherein separate part has been inserted for certifying the amount of expenditure from year to year and the amended form No. 3CL thus, lays down the procedure to be followed by the prescribed authority. Prior to the aforesaid amendment in 2016, no such procedure/methodology was prescribed. In the absence of the same, there is no merit in the order of Assessing Officer in curtailing the expenditure and consequent weighted deduction claim under section 35(2AB) of the Act on the surmise that prescribed authority has only approved part of expenditure in form No. 3CL. We find no merit in the said order of authorities below.

46. The Courts have held that for deduction under section 35(2AB) of the Act, first step was the recognition of facility by the prescribed authority and entering an agreement between the facility and the prescribed authority. Once such an agreement has been executed, under which recognition has been given to the facility, then thereafter the role of Assessing Officer is to look into and allow the expenditure incurred on in-house R&D facility as weighted deduction under section 35(2AB) of the Act. Accordingly, we hold so. Thus, we reverse the order of Assessing Officer in curtailing the deduction claimed under section 35(2AB) of the Act by Rs. 6,75,000/-. Thus, grounds of appeal No.10.1, 10.2 and 10.3 are allowed.”

14.8 The question of allowing deduction u/s.35(2AB) of the Act was considered by the Hon’ble Delhi High Court in the case of CIT v. Sadan Vikas (India) Ltd. [2011] 335 ITR 117 (Del) where AO refused to accord the benefit of the weighted deduction to the assessee under s. 35(2AB) on the ground that recognition and approval was given by the DSIR in February/September, 2006, i.e., in the next assessment year and, therefore, the weighted deduction cannot be allowed. In this case, the CIT(A) confirmed the order of the AO. The Tribunal held that the assessee would be entitled to weighted deductions of the aforesaid expenditure incurred by the assessee in terms of the s. 35(2AB) of the Act and in coming to this conclusion, the Tribunal relied upon the judgment of Gujarat High Court in CIT v. Claris Lifesciences Ltd. 326 ITR 251 (Guj). In its decision the Hon’ble Gujarat High Court had held that the cut-off date mentioned in the certificate issued by the DSIR would be of no relevance. What is to be seen is that the assessee was in indulging in R&D activity and had incurred the expenditure thereupon. Once a certificate by DSIR is issued, that would be sufficient to hold that the assessee fulfils the conditions laid down in the aforesaid provisions. The Hon’ble Delhi High Court followed the decision of the Hon’ble Gujarat High Court and upheld the decision of the Tribunal. The Hon’ble Delhi High Court quoted the following observations of the Hon’ble Gujarat High Court and agreed with the said view:

“7. … The lower authorities are reading more than what is provided by law. A plain and simple reading of the Act provides that on approval of the research and development facility, expenditure so incurred is eligible for weighted deduction.

8. The Tribunal has considered the submissions made on behalf of the assessee and took the view that section speaks of : (i) development of facility; (ii) incurring of expenditure by the assessee for development of such facility; (iii) approval of the facility by the prescribed authority, which is DSIR; and (iv) allowance of weighted deduction on the expenditure so incurred by the assessee.

9. The provisions nowhere suggest or imply that research and development facility is to be approved from a particular date and, in other words, it is nowhere suggested that date of approval only will be cut-off date for eligibility of weighted deduction on the expenses incurred from that date onwards. A plain reading clearly manifests that the assessee has to develop facility, which presupposes incurring expenditure in this behalf, application to prescribed authority, who after following proper procedure will approve the facility or otherwise and the assessee will be entitled to weighted deduction of any and all expenditure so incurred. The Tribunal has, therefore, come to the conclusion that on plain reading of s. itself, the assessee is entitled to weighted deduction on expenditure so incurred by the assessee for development of facility. The Tribunal has also considered r. 6(5A) and Form No. 3CM and come to the conclusion that a plain and harmonious reading of rule and Form clearly suggests that once facility is approved, the entire expenditure so incurred on development of R&D facility has to be allowed for weighted deduction as provided by s. 35(2AB). The Tribunal has also considered the legislative intention behind above enactment and observed that to boost up research and development facility in India, the legislature has provided this provision to encourage the development of the facility by providing deduction of weighted expenditure. Since what is stated to be promoted was development of facility, intention of the legislature by making above amendment is very clear that the entire expenditure incurred by the assessee on development of facility, if approved, has to be allowed for the purpose of weighted deduction.”

From the above discussion it is clear that prior to 1-7-2016 Form 3CL had no legal sanctity and it is only w.e.f 1-7-2016 with the amendment to Rule 6(7A)(b) of the Rules, that the quantification of the weighted deduction u/s.35(2AB) of the Act has significance. Further, the date of approval shall not be cut off date for allowing scientific research expenditure u/s 35(2AB) of the Act.

39. Considering that the facts for the year under consideration being similar, we respectfully follow the above decision and see no infirmity in the order of the CIT(A) allowing the weighted deduction towards the amount not approved by DSIR.

Cross Objection No. 01/Mum/2022 – Assessee’s

40. The cross objections raised by the assessee are tabulated in the earlier part of the order and from the perusal of the same, it is clear that the issues contended are similar to revenue’s appeal in ITA No.1242/Mum/2021. Therefore our decision with regard to those issue while adjudicating revenue’s appeal is mutatis mutandis applicable to the cross objections of the assessee. It is ordered accordingly.

41 In the result, the appeal of the assessee in I.T.A.No.77/Mum/2021 is allowed for statistical purposes, the appeal of the revenue in I.T.A. No. 1241/Mum/2021 are partly allowed. The appeal of the revenue in I.T.A. No. 1242/Mum/2021 is dismissed and the assessee’s C.O.No.1/Mum/2022 is allowed.

Order pronounced in the open court on 18-03-2024.