Case Law Details

Case Name : ACIT Vs. Parablic Drugs Ltd. (ITAT Delhi)
Appeal Number : ITA No. 2111/Del/2010
Date of Judgement/Order : 17/06/2011
Related Assessment Year : 2006- 07

ITAT DELHI

ITA No. 2111/Del/2010

Assessment Year: 2006- 07

ACIT Vs. Parablic Drugs Ltd.

ORDER

PER I.P. BANSAL, J.M.

This is an appeal filed by the revenue. It is directed against the order passed by ld. CIT(A) dated 24.02.2010 for A.Y. 2006-07. Grounds of appeal read as under: –

1. “That on the facts and circumstances of the case and in law the ld. CIT(A) erred in deleting the addition of Rs. 7,10,95,947/- made by the AO on account of dis-allowance of  expenditure on R&D being capital in nature.

2. That on the facts and in the circumstances of the case, the ld. CIT(A) erred in directing the AO to allow the deduction u/s 80IB of the I. T. Act, 1961 if it is otherwise allowable without appreciating the fact that the assessee has not made any such claim in its return of income.
3. The appellant craves to the allowed to add, delete or amend any other grounds of appeal.”
2. The assessee is a limited company engaged in the business of manufacture of bulk drugs and fine chemicals etc. The return of income originally was filed on 7.11.2006 declaring its total income at Nil after claiming weighted deduction of expenditure incurred on in-house Scientific Research & Development of Rs. 7,82,53,487/- against which in terms of provisions contained in sec. 35(2AB) of the Income Tax Act, 1961 (Act), the admissible deduction @ 150% was computed at Rs. 11,73,80,230/-. In view of total income computed at Rs. 8,74,75,594/- the deduction u/s 35(2AB) was restricted to that amount and income was computed at Nil. As under the normal provisions computable income was Nil the tax was paid on book profit u/s 115JB and book profit was computed at Rs. 9,21,42,714/-.
3. The breakup of total expenditure of Rs. 7,82,53,487/- incurred on Research & Development in drugs and pharmaceutical constituted of cost of fixed assets shown in the balance sheet at Rs. 44,41,522/- and balance sum of Rs. 7,38,11,965/- was shown under the head “miscellaneous expenditure” in the balance sheet as on 31.3.2006.
4. The assessee company was approved company u/s 35(2AB) by the appropriate authority called as “DSIR”. Such recognition granted by DSIR was up to 31.3.2010. The assessee had made an application to DSIR claiming the benefit of 11,73,80,230/- u/s 35(2AB) of the Act. However, DSIR approved capital expenditure of Rs. 41,69,868/- and the revenue expenditure at Rs. 27,16,018/- both aggregating to Rs. 68,85,886/- and on the basis of such approval the assessee revised its return of income on 7.11.2007 declaring its revised total income at Rs. 60,50,820/-. It claim deduction of Rs. 1,03,28,830/- being 150% was approved amount u/s 35(2AB) and the balance expenditure of Rs. 7,10,95,947/- was claimed to have been incurred on revenue account which was on materials, salaries etc. used for in-house research and development as these were not approved for claiming weighted deduction u/s 35(2AB). These expenditures have been shown as deferred revenue expenditure in the balance sheet on the assets side of the balance sheet under the head “miscellaneous expenditure”.

5. In the impugned assessments, the AO has disallowed the claim of the assessee of sum of Rs. 7,10,95,947/- being on account of revenue expenditure and has treated the said amount as capital expenditure. The reason for disallowance given by the AO is that the said amount has been shown under the head “miscellaneous expenditure” in the balance sheet, therefore, it is a capital expenditure. According to AO the assessee itself has classified the said amount as capital in nature in its audited balance sheet. Once expenditure as has been identified and classified as capital in nature, based on its purpose and intent the non-approval by DSIR does not change the character of the expenditure as revenue. There is no provision in the Income Tax Act to say that if expenditure is not approved, the same shall constitute revenue in nature. In the audited account also these expenditures have been identified as capital expenditure, therefore, the nature of expenses being capital is undisputed. An auditor’s opinion on the quantum of capital expenditure is not dependent upon result of approval of DSIR. The assessee has failed to adduce any evidence or any certification from DSIR that the said balance unapproved amount is a revenue expenditure.

6. The details of these expenditures were furnished. The total expenditure has been classified in four broad items and from the details the AO has summarised the position as under: –

1. “Capital Expenditure Rs. 44.41 lacs

The major capital expenditure includes expenditure for purchase of HPLC Columns i.e. High Pressure Liquid Chromato graph Column. High performance liquid chromatography (or High pressure liquid  chromatography , HPLC) is a form of column chromatography used frequently in biochemistry and analytical chemistry to separate, identify and quantify compounds. HPLC utilised a column that hold chromatographic packing material (stationary phase), a pump that moves the mobile phase(s) through the column, and a detector that shows the retention times of  the molecules. Retention time varies depending on the interactions between the stationary phase, the molecules being analysed, and the solvents used. These are very essential high tech testing equipment for the testing and chemical analysis of raw material, chemicals, in process material and final products and to establish the quality parameters for the product.

2. Salary & Wages Rs. 19.57 lacs

The expenditure on salary and wages include the salaries! wages paid to the manpower deployed for carrying out the research and development activity. They are highly experienced and qualified technical people in their respective field and are graduates, post graduates and doctorate. There is a separate dedicated team, who helps in developing new molecules and process improvement of the existing products. It is pertinent to note that a research and development is a key to the growth of any industry particularly the pharmaceutical to be abreast with the latest technology and process.

3. Material/ Consumables/ Spares Rs. 611.78 lacs 

 These are the materials! chemicals! consumables! spares used in carrying out the research and development activity. Quite a large number of chemicals! consumables are required for the testing, analysis and use of the same in the normal course of process development. In the process development different permutations and combinations are tried to develop new molecules, to improve the yield of the existing products, so that cost of products is minimised and be competitive.  This expenditure was incurred on account of R&D lab trial and to scale up of technology.

4. Other expenditure directly related to R&D Rs. 106.77 lac

This expenses comprises of amount incurred for technical consultancy! assistance, Registration of product, for contribution to national laboratory etc.”

7.  The reply of the assessee vide letter dated 20.12.2008 was as under: –

“During the F. Y. 2005-06 the company has incurred the total of Rs. 7,82,53,487/- on scientific research and development under the following heads of accounts:

(A) Capital Expenditure

(B) Salary & Wages

(C)  Materials/ consumables/ spares

(D) Other revenue expenditure

and weighted deduction is admissible u/s 35(2AB) @ 150% but limited to taxable profit before deduction u/s 35(2AB). The company has capitalised all the expenditure incurred. The capital expenditure has been shown in schedule of fixed assets and revenue  expenditure such as salary and wages, material/ consumables/ spares under the head “miscellaneous expenditure” on the assets side in the balance sheet. In fact all these expenditure are of revenue nature and should be charges to profit and loss account but has been shown under miscellaneous expenditure to present the better position of profit and loss account and to attract the shareholder. However, the due effect in the computation of income has been correctly shown considering the provision of the Income Tax Act. In our case as per accounting policy followed by the company it has been decided to write off the expenditure shown under the head “miscellaneous expenditure” over a period of five years.

Further, revenue expenditure, which is incurred wholly and exclusively for the purpose of business must be allowed in entirely in the year in which it is incurred. It cannot be spared over a number of years even if the assessee has written off in his books over a period of years.”

8. The AO has observed that an amount of Rs. 6,11,77,948/- has been shown by the assessee as incurred on R&D Lab Trial. The  expenditure is incurred mainly on the materials/ chemicals/consumables/spares used in carrying out the Research & Development activity on Lab Trial for process development. Such fact clearly establishes that the amounts incurred on various items during previous year were used just for trial production and actual production did not come out. Commercial production was to be started only after 2 to 3 years after the complete process was handed over to the production department and earliest possible date for that is only September, 2006 i.e., beyond the relevant previous year. Therefore, the expenditure on trial production is nothing but capital. Out of other expenditure related to R&D of Rs. 1,06,77,233/-, an amount of Rs. 2,57,176/- was spend towards registration of product in various countries and Rs. 1,04,20,057/- is paid to various parties for technical assistance in respect of which assessee has failed to highlight the exact nature of technical assistance obtained to prove that it was revenue in nature.

9. The AO also perused the details filed by the assessee in form 3CK pertaining to additional information submitted to DSIR in which the estimated time of completion of the trial process for handing over the process to the production department was mentioned. Therefore, the AO observed that expenditure incurred during the trial run before its commercial exploitation was capital in nature. The expenditure had a degree of indurability and permanence to the technical know how and it spread over a long period of time and in the circumstances ld. AO has held that the claim of the assessee regarding a sum of Rs. 7,10,95,947/- on account of its being revenue expenditure is not acceptable and he has added the said amount to the income of the assessee and the AO has assessed the income of the assessee at Rs. 7,71,46,764/-. Since tax payable under normal computation was more, the book profit computed by the assessee was ignored.

10. The addition was contested before CIT(A). An additional ground of appeal was filed before CIT(A) in which the assessee had claimed that without prejudice to its claim of the aforementioned amount as revenue expenditure the expenditure is otherwise allowable u/s 35(1)(i) of the Act being in the nature of revenue expenditures, laid out or expanded on Research & Development related to the business of the assessee company. It was pleaded that additional ground should be admitted as all the facts needed are available on record and the ground is purely legal one. Ld. CIT(A) has admitted the additional ground of the assessee and has thus, examined the claim of the assessee for allowability or otherwise of aforementioned amount under both the sections namely 37(1) and 35(1)(i). The assessee also filed written submissions which have been reproduced in the order of CIT(A) and which was also forwarded to AO and remand report was also submitted by the AO dated 9th September, 2009. The AO submitted that additional ground furnished by the assessee may be admitted for adjudication. The AO submitted that from the assessment it is clear that the use of new process of in-house Research & Development amounts to new venture which is not in the line of assessee’ s existing business. The benefit of such R&D/process is enduring nature and the expenditure of Rs. 7.10 crore is not approved from the competent authority. Therefore, the expenditure is of capital in nature and cannot be allowed in the year under consideration. The AO oppose the allowability of such expenditure u/s 37(1) as it does not cover the expenditure described in sec. 30 to 36 as well as the expenditure is in the nature of capital expenditure or personal expenditure of the assessee. Hence, AO opposed the allowability of these expenditures on the ground that those are expenditure of capital in nature. The rejoinder filed by the assessee vide letter dated 12th October, 2009 is also reproduced in the order of CIT(A) in para 4.5. The AO also submitted second remand report dated 16.12.09 which has been reproduced in para 4.8 of the order of CIT(A) and the rejoinder of the assessee on second remand report is reproduced in para 4.9 of the order of CIT(A).

11. Considering all these submissions, ld. CIT(A) has deleted the disallowance vide para 4.11 of his order. According to ld. CIT(A), while disallowing the impugned amount the AO has broadly specified the following reasons: –

a) “The expenditure incurred by the assessee is capital expenditure since it has been shown in the Balance Sheet.

b) the materials! chemicals!consumable used in carrying out research and development activity for process development are expenditure incurred on trial production of the drugs hence capital expenditure.

c) The expenditure incurred on trial production, before completion of process is part of research and development and it is capital expenditure.”

12. He has classified total expenditure incurred by the assessee amounting to Rs. 7,82,53,487/- in the following table: –

Amount (Rs.) (In lacs)
Cost of Capital Equipments (A)  

44.41

Materials/ Consumables/ Spares

611.78

Salaries and Wages

19.57

(B)  

631.35

Registration of products in
various countries

2.57

Fee for Technical assistance

104.20

(C)

106.77

Total Revenue Expenditure (B+C)

738.12

Grand Total (A +B+ C)

782.53

13. Ld. CIT(A) has held that accounting entry in the books of account of the assessee or for that matter how it has been shown in the balance sheet or profit and loss account is of no consequence in determining that whether it is an allowable deduction or not and reference in this regard has been made to the decision of Honourable Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. Vs. CIT 227 ITR 172 (SC). He held that the expenditure having been incurred on R&D and they being in the nature of revenue could not be held of capital in nature even though they are described as deferred revenue expenditure in the balance sheet filed by the assessee. He held that nomenclature used by the assessee is “deferred revenue expenditure” which would mean that it talks about revenue expenditure though shown in the balance sheet for accounting purposes. He found that the assessee has claimed the said amount of Rs. 7,10,95,947/- in the computation of income submitted in the return of income. Ld. CIT(A) also held that non-approval of revenue expenditure for weighted deduction u/s 35(2AB) of the Act by DSIR would not mean that the expenditure is no longer revenue expenditure. He observed that in case the capital expenditure is not approved by DSIR, it would not mean that it is not capital expenditure for accounting purpose in the books of account on which no depreciation is allowable. Similarly, non-approval of revenue expenses by DSIR will not change the character of revenue expenditure. Ld. CIT(A) observed that this can never be the intention of the law. The expenditure incurred on R&D is also business expenditure, allowable as deduction u/s 35(1)(i) of the Act.

14. Ld. CIT(A) has further held that assessee company was incorporated in the year 1996 and is in this line of business of manufacture of drugs ever since then. Its turnover has increased every year. There is a force in the argument of the assessee company that expenditure on R&D cannot be considered as expenditure incurred on trial run especially when the assessee company is in the business for many years. The expenditure incurred on R&D even in the course of trial for drugs, if and only if it is not capital expenditure, has to be allowed as deduction u/s 35(1)(i) of the Act. The AO did not doubt the genuineness of the expenditure incurred on R&D which is also a separate wing within the factory premises of the assessee.

15. It is further held by ld. CIT(A) that the expenditure on R&D in the course of trial runs for new drugs cannot be classified as capital expenditure on the ground that with each successful trial run, a new venture/unit comes into existence. Even if expenditure is incurred on trial run in a business whether or not related to separate R&D activity does not constitute a new venture/ unit. The AO has not proved that assessee has started altogether a new unit to be set up completely independent of its existing unit. If the expenditure of revenue in nature are incurred on account of commercial expediency, it has to be allowed as deduction u/s 37(1) of the Act, if those are not specifically covered for deduction u/s 36 of the Act and those are to be allowed u/s 37(1) of the Act. But they cannot be ignored altogether. Therefore, time for completion of trial runs of medicines lost its relevance and the principles of enduring benefit break down.

16. Ld. CIT(A) has further held that incurrence of expenditure at all is not doubted by the AO. The findings of AO that R&D expenses are in the nature of capital are based on suspicion, surmises and conjunctures. Therefore, entire expenditure of Rs. 7,38,11,965/- are genuine expenditure incurred by the assessee. The DSIR has allowed Rs. 27.16 lakh for weighted deduction out of entire revenue expenditure of Rs. 7.38 crore. The balance expenditure of Rs. 7,10,95,947/- is also in the nature of revenue and constitute aggregated sum of Rs. 6,11,77,948/- incurred towards material costs etc., Rs. 19,56,784/- on salary and wages and Rs. 1,06,77,233/- incurred for getting registration of products in other countries or towards obtaining technical know how fee for producing new drugs etc. Ld. CIT(A) has observed that he had called for and perused the agreement of the assessee company and Ind. Swift Ltd. for transfer of technical know how. The AO did not give any adverse comment on this issue in the remand report. Such agreements for transfer of technical know how are quiet common in pharmaceutical Industry due to commercial exigencies and he has relied upon the following decisions: –

i) JCIT Vs. Modi Olivetti Ltd. 3 SOT 22 (Del.)

ii) ACIT Vs. Medicemen Biotech Ltd. 1 SOT 347.

The department is aggrieved with such findings of ld. CIT(A) and hence ground no. 1 has been raised to assail such findings.

17. With regard to ground no. 2 the discussion is only found in para 5 of the order of CIT(A). Ld. CIT(A) has directed the AO to recomputed the income as per appeal effect and consider the claim of the assessee in accordance with law, if the same is otherwise allowable. In respect of these directions of ld. CIT(A) department has raised ground no. 2.
18. After narrating the facts, it was vehemently pleaded by ld. DR that originally assessee made a claim of Rs. 11,73,80,230/- u/s 35(2AB) on the ground that the expenditure incurred by the assessee on in-house Scientific Research & Development falls under that section. As against that DSIR approved only an amount of Rs. 41,69,868/- on account of capital expenditure and 27,16,019/- on account of revenue expenditure. In the revised return out of total expenditure of Rs. 7,38,11,965/- capitalized and shown under “miscellaneous expenditure” in the balance sheet an amount of Rs. 7,10,95,947/- was claimed as revenue expenditure as the balance amount of Rs. 27,16,019/- was already given approval by DSIR for claiming benefit u/s 35(2AB). Thus, in the revised return the assessee had claimed amount of Rs. 7,10,95,947/- as an expenditure allowable u/s 37(1) of the Act. He submitted that the object of the assessee for incurring such expenditure was to develop new molecules as well as cost effective processes for existing products. According to form no. 3CK pertaining to additional information submitted by the assessee to DSIR, the earliest date of completion of any of the process was September, 2006 which does not fall within the relevant financial year. Similarly, for the other products the plant trials and full production could be started only in subsequent years i.e. financial year 2007-08 onward. He submitted that these facts have clearly proved that the expenditure incurred on research and development during the year was for the purposes of deriving enduring advantage to the assessee company. Benefit of such expenditure was not restricted to the year under consideration but it was to spread over for many years. These were expenditure incurred on in-house Research & Development once and for all with a view to bring into existence an asset or advantage for the enduring benefit to the assessee. The assessee itself has classified these expenditure as capital in nature in its audited balance sheet and if once expenditure has been identified and classified as capital in nature, based on its purpose and intent, the non-approval by DSIR does not change the character of the expenses from capital to revenue and there is no provision in the Income Tax Act to change the capital expenditure on non-approval by DSIR into revenue expenditure. In the audited accounts the expenditure has been identified as capital expenditure and, therefore, the nature of these expenditure being capital is undisputed. The assessee also failed to adduce any evidence or any certification from DSIR that said unapproved balance is revenue expenditure. Ld. DR further submitted that an amount of Rs. 6,11,77,948/- shown by the assessee being incurred on Research & Development Lab trial is incurred mainly on the material/ chemicals/ consumables/ spares used in carrying out the R&D activity on Lab trial for process development and such fact clearly established that the amount incurred on various items was used just for trial production and actual production did not commence. Commercial production was to start only after 2-3 years after the complete process was handed over to the production department for which the earliest possible date was September, 2006 which falls beyond the relevant previous year. Further out of other expenditures related to R&D amounting to Rs. 1,06,77,233/- an amount of Rs. 2,57,176/- was spent towards registration of product in various countries and Rs. 1,04,20,057/- was paid to various parties for technical assistance for which the assessee has failed to highlight the exact nature of technical assistance obtained by it so as to determine the nature of such expenditure and thus, it was pleaded by ld. DR that the claim of the assessee of an expenditure of Rs. 7,10,95,947/- was rightly disallowed by the AO on account of the same being capital expenditure and thus, the AO was right in rejecting the claim of the assessee of allowability of the same u/s 37(1) of the Act. Ld. CIT(A) has wrongly accepted the claim of the assessee.

19. Ld. DR submitted that before CIT(A) the assessee had filed additional ground according to which these expenditures were claimed by the assessee under the provisions of sec. 35(1)(i) of the Act. He submitted that ld. CIT(A) was wrong in admitting such additional ground and accepting the claim of the assessee regarding deduction u/s 35(1)(i) of the Act. He submitted that ld. CIT(A) is also wrong in holding that expenditure incurred on trial runs also constitute revenue expenditure. Therefore, he pleaded that assessee’s claim has wrongly been allowed by ld. CIT(A). His order should be set aside and that of AO be restored.

20. Coming to ground second, it was submitted by ld. DR that assessee did not put such claim before AO the AO has not discussed any such claim and, therefore, CIT(A) was wrong in admitting such ground of the assessee.

21. On the other hand, it was submitted by ld. AR that the assessee company is engaged in the business of manufacturing of bulk drugs. As a part of necessity of the business of the assessee it has to make new R&D regarding molecules being used in the existing drugs so that the product is continuously improved and the product become cost effective. For that purpose assessee has carried out in-house Research facility and necessary documentation were done to have approval from the prescribed authority i.e. DSIR under the provisions of sec. 35(2AB) so that assessee may get weighted deduction provided under that section to the extent of 150%. The norms fixed by DSIR are stiff and, therefore, assessee was unable to get such approval with regard to entire expenditure incurred by the assessee and it got partial approval on which the assessee had claimed weighted deduction u/s 35(2AB) which has been allowed by the AO and on the said amount there is no dispute. He submitted that what was capital in nature has already been classified as capital and depreciation has been claimed upon that. On the balance expenditures which are revenue in nature the assessee has claimed them u/s 37(1) of the Act in the revised return. He submitted that otherwise those expenses having been incurred on Research & Development facilities also fall under the provisions of sec. 35(1)(i) of the Act for which an additional ground was raised by the assessee before ld. CIT(A) and AO in his remand report did not object for admission of such additional ground. On the basis of reasons given by ld. CIT(A), the claim of the assessee has been accepted under both the sections being eligible u/s 35(1)(i) and also u/s 37(1) of the Act. He submitted that nature of expenditure itself will describe that all these expenditures were otherwise of revenue in nature which did not generate any capital asset to give enduring benefit to the assessee. He submitted that AO is factually incorrect in observing that assessee in its books of account has shown these expenditures as capital expenditure. He submitted that assessee has never shown these expenditure as capital in nature. These expenditures have been classified as “deferred revenue expenditure” under the head “miscellaneous expenditure”. He in this regard referred to the relevant portion of audited accounts. Therefore, he submitted that AO is wrong in saying that assessee itself has shown those expenditure as capital expenditure. He submitted that nomenclature given by the assessee to an item of expenditure cannot be determinative of the nature of expenditure as on the facts of the case it has to be seen that whether the expenditure incurred is of capital in nature or it is in the nature of revenue. For this proposition ld. AR has relied upon the following decisions: –

(i) “Tuticoren 172 ITR 227 (SC)

(ii) Challapalli Sugar Ltd. 98 ITR 167

(iii) CIT V. Seshsayee Paper and Boards Ltd. 156 ITR 542 (Mad.)

(iv) Jat Parabolic 6 DTR 233”

22. He submitted that it will be incorrect to say that if under one section the claim of the assessee does not fall, then assessee cannot claim the same under any other section. He submitted that it is permissible to the assessee to claim any expenditure under any other section, if it is not held to be allowable under a particular section. For this proposition he has relied upon the decision in the case of Tata Chemicals Limited Vs. CIT 195 ITR 561.
23. For the proposition that the expenditures have rightly been held to be revenue in nature by ld. CIT(A), ld. AR has further placed reliance on the following decisions: –

1. “Research and development expenditure on developing of existing product, cost effective  method and new products

(i) Empire Jute Co. Ltd. (1980) 124 ITR 1 (SC) “If the advantage consists merely in facilitating the assessee ’s trading operations or enabling the management and conduct of the assessee ’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future.”

In case of the appellant, no capital asset has come into existence. The business has been in existence since long. The existing medicinal products are being improved and new products are being created for facilitating the assesse ’s trading operations. Hence, the expenditure is revenue in nature.

(ii) Alembic Chemical Works Co. Ltd. (1989) 177 ITR 377 (SC)

a. Expenditure on improved process of fermentation with new penicillin producing strains, isolated and developed by Meiji so as to increase the unit yield of penicillin per millilitre of the culture medium.

b. The improvisation in the process and technology in some area of the enterprise was supplemental to the existing business and there was no material to hold that it amounted to a new or fresh venture. The financial outlet was for the better conduct and improvement in existing business and should, therefore, be held to be revenue.

c. What is material to consider the nature of advantage in a commercial sense and it is only when the advantage is in the capital filed that the expenditure would be dis-allowable.

In the case of the appellant also, the business was in existence and the research and development merely enabled the appellant to develop its existing products in terms of quality and efficiency. In the above said case, the capital incurred on purchase of technology for improving the process of manufacture was held to be revenue in nature.

(iii) ACIT V. Medicamen Biotech Ltd. (2006) 99 TTJ (Del) 873– The expenditure incurred towards launching the new product was held to be revenue in nature even though the said expenditure was considered as deferred revenue expenditure in the books of account.

The judgment of Madras Industrial Investment Corporation Ltd. v Commissioner of Income Tax, 225 ITR 802) distinguished at page 880.

(iv) Indo Rama Synthetic (I) Ltd. V. CIT (2010)  228 CTR (Del) 278– A new unit was to be set up which would have an inextricable linkage with the business of the appellant. Expenditure incurred was in the nature of salary, wages, repairs, maintenance, traveling, engineering fee etc. The expenditure was considered to be revenue in nature more so that the project was amended and no new assets to be created.

(v) CIT V. Denso India Ltd. (2009) 318 ITR 140  (Del) – The assessee was engaged in the manufacturing of auto electrical parts for which, it was importing several components. The assessee considered that instead of importing the components, it would be beneficial to have components locally procured and indigenously manufactured and for this, it set up a separate cell for developing, imported substituted components. The expenditure incurred by the assessee on salary, wages, traveling etc. was shown under the head “deferred revenue expenditure”. Held that the expenditure incurred was revenue in nature and merely because the benefit of the expenditure was also available later, was not ground to consider this expenditure as capital.

It may be appreciated that in the said case, the expenditure was incurred for developing of new products. Considering the nature of expenditure, it was held to be revenue.

In the appellant’s case also, the expenditure was on material, salaries, registration etc. Hence, it was on the revenue account and no new capital asset came into existence.

(vi) Good Year India Ltd. 249 ITR 239 (Del) – The assessee entered into an agreement for enlarging the range of its existing products and acquired the right to use the technology of manufacture of a new product in the same line of business. The expenditure was allowed as revenue on the ground that the assessee had only enlarged the range of its existing products and the expenditure was an outlay of business in order to carry it on to earn better projects.

(vii) The Mumbai Tribunal in the case of Arlabs Lid. 5 SOT 749 held that an expenditure towards research and development for carrying out modification and addition with a view to produce new items was allowable as a revenue expenditure. Hence, the power, fuel and interest expenditure incurred were allowed.

(viii) USV Lid. 106 TTJ 585 (Mum.) – Expenditure incurred for information regarding clinical data, scientific details and valuable market information was allowed as revenue expenditure.”

24. Thus, it was pleaded by ld. AR that the claim of the assessee has rightly been allowed by ld. CIT(A) and his order should be upheld.
25. With regard to second ground he submitted that there is nothing wrong in the order of CIT(A) when he has directed the AO to recompute the income of the assessee as per appeal effect and consider the claim of the assessee in accordance with law.

26. We have carefully considered the rival submissions in the light of material placed before us. The details of these expenditure has been provided by the assessee as Annexure C&D in the paper book from pages 46 to 47 of a sum of Rs. 6,11,77,948.16/-, which described it as “details of material used for lab trials for process development for the year ending 31.3.2006” and details of Rs. 1,06,77,233/- is the “details of other expenditure directly related to R&D” for the year ending 31.3.2006. The AO in the assessment order has broadly discussed these details under the four heads which have already been reproduced in the above part of this order in para 6. From the said detail, it can be seen that capital expenditure amounting to Rs. 44.41 lakh has been categorised by the assessee as capital expenditure and to that expenditure there is no dispute because they have been considered as capital expenditure by the assessee itself. The another head is “salary and wages” of Rs. 19.57 lakh. This expenditure relates to salary and wages paid to the manpower deployed for carrying out R&D activity. So in itself it did not create any asset which could give assessee an enduring benefit. The third head is material/ chemicals/consumables/spares of Rs. 611.78 lakh. These expenditures have been incurred on materials/chemicals/ consumables/spares used in carrying out the R&D activity. It is the case of the assessee that for carried out research activity a large number of chemicals/consumables are required for the testing, analysing and use of the same in the normal course of process development. In the process development different permutation and combination are tried to develop new molecules, to improve the yield of the existing products, so that the cost of the product is minimised and be competitive. The fourth and final head is “other expenditure” which is directly related to R&D and is amounting to Rs. 106.77 lakhs and this expenditure comprises an amount incurred for technical consultancy/assistance, registration of product, for contribution to national laboratory etc.

27. Therefore, the nature of these expenditures is not in dispute and their incurrence by the assessee on R&D programme are also not disputed. Firstly, it is the claim of the assessee that such expenditure falls under the provisions of sec. 35(1)(i) of the Act and, alternatively it is allowable u/s 37(1) of the Act. To examine such contention it will be relevant to reproduce section 35(1)(i), which read as under: –

“[Expenditure on scientific research.

35. (1) In respect of expenditure on scientific research, the following deductions shall be allowed –

(i) any expenditure (not being in the nature of capital expenditure) laid out or expended on scientific research related to the business.

[Explanation – Where any such expenditure has been laid out or expended before the commencement of the business (not being expenditure laid out or expended before the 1st day of April, 1973) on payment of any salary [as defined in Explanation 2 below sub-section (5) of section 40A] to an employee engaged in such scientific research or on the purchase of materials used in such scientific research, the aggregate of the expenditure so laid out or expended within the three years immediately preceding the commencement of the business shall, to the extent it is certified by the prescribed authority to have been laid out or expended on such scientific research, be deemed to have been laid out or expended in the previous year in which the business is commenced;]”

28. Section 35(1)(i) falls under chapter IV under the head “computation of business income”. It describes the allowability of the expenditure in case where business income is computed. It deals with the expenditure incurred by the assessee on scientific research. It has been prescribed therein that in respect of expenditure on scientific research the same will be allowed if the said expenditure has been laid out or expanded on scientific research related to the business. It is not the case of anybody that explanation to sec. 35(1)(i) of the Act is applicable to the facts of the case. Therefore, the case of the assessee has to be seen in the light of provisions contained in sec. 35(1)(i) without application of explanation. As mentioned earlier the business of the assesse is of manufacturing of bulk drugs and fine chemicals etc. In the process of its manufacturing of drugs it has to make research and development so to make the drug more effective and also to bring down the cost. No material has been brought on record to suggest that by incurring these expenditure the assessee has entered into any new activity of manufacturing or new activity of trade. In the business of manufacturing of drug, process of R&D is continuous process which augment the business of the assessee. These expenses are not in the nature of any personal expenditure as no such allegation has been made. Therefore, the remaining criteria to consider the allowability is only the thing to be seen is that whether the expenditure is incurred by the assessee is capital in nature. As mentioned earlier the details of these expenditures have already been described by the AO in summarized form and details of these expenditures are also found place in the paper book filed by the assessee. So as it relates to capital expenditure of 44.41 lakh, the assessee itself has claimed the said expenditure as being capital in nature. Therefore, there is no dispute with regard to that. So as it relates to expenses of 19.57 lakh on salary and wages the same cannot be considered to be expenditure of being capital in nature as the said salary and wages are paid to the man power deployed for carrying out the R&D activity which is part and parcel of the business of the assessee.

29. Now coming to the expenses of 611.78 lakh relating to material/consumable/spares. The detail of these expenditures has been incorporated at page 46-47 of the page. The narration given is “details of material used for lab trials for process development”. These are in the nature of 7-ACA, 6-APA, Acetonitrile, Ammonia, Activated Carbon, AMF SMIA, Acetone, Dry Ice, Caustic Soda, ACETIC ACID, Pavlic Acid, Penicillin G, PCL 5, etc. All these items are in the nature of material/consumables in the process of R&D. It is not the case of the AO that the said material was not consumed in the R&D process and some part thereof was remaining in the closing stock. Therefore, these expenditure incurred on material used for lab trials cannot in any manner be considered as expenditure being in the nature of capital. The next item is “other expenditure directly related to R&D”. The details of these expenditure are incorporated at page 48 of the paper book. It is under the head “details of other expenditure directly related to R&D”. With regard to these expenditure the finding of fact has been recorded by ld. CIT(A) that these have been incurred by the assessee for registration of products in other countries or towards obtaining technical know how fee for producing new drugs etc.. He has recorded in his order that he has called for and perused the agreements between the assessee company and Ind. Swift Ltd. (which is the major sum of 1 crore comprising of two items of Rs. 50 lakh each) for transfer of technical know how. He has also observed that AO has not given any adverse comment in his report regarding this agreement and such type of agreements for transfer of technical know how are quite common in pharmaceutical industry due to commercial exigency. These findings of fact have not been controverted by the revenue by bringing any material on record to suggest that such findings of ld. CIT(A) are contrary to the facts existing on record. If it is so, then we find no infirmity in the findings recorded by ld. CIT(A), whereby following the decision of Delhi ITAT in the cases of JCIT Vs. Modi Olivetti Ltd. (supra) and ACIT Vs. Med-icemen Biotech Ltd. (supra), he has allowed the relief to the assessee.

30. In view of the above discussion, it has to be held that all of these expenditure were incurred by the assessee in the course of its business and none of the expenditure can be classified as expenditure in the nature of capital. The case law relied upon by the ld. AR supports the case of the assessee. Therefore, we found no infirmity in the order of CIT(A) vide which the assessee has been held eligible for deduction of these expenditure under both the sections either u/s 35(1)(i) or u/s 37(1) of the Act. We decline to interfere in such deletion and this ground of the revenue is dismissed.

31. So as it relates to claim of the assessee u/s 80IB, it was found that this claim was not made by the assessee in the return of income, it was also not made during the course of assessment proceedings. The facts relating to that deduction have also not been shown to be existing on record. Ld.CIT(A) without considering this aspect has directed the AO to examine the claim of the assessee in accordance with law. When the facts regarding such deduction were not available on record and the ground was also not arising out of assessment order, then, in our opinion ld. CIT(A) has committed an error in entertaining such ground. Therefore, this ground of the revenue is allowed.

32. In the result, the appeal filed by the revenue is partly allowed in the manner aforesaid.

Order was pronounced in the Open Court on 17.06.2011

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