The Finance Bill, 2009 has introduced changes in the provisions relating to deduction for scientific expenditure incurred by an assessee in connection with his business. Clause 12 of the Finance Bill, 2009 proposes to substitute the following words in sub-section 2AB of section 35 of the Income-tax Act:
“the business of manufacture or production of any drugs, pharmaceuticals, electronics equipments, computers, telecommunication equipments, chemicals or any other article or thing notified by the Board”
The above words are proposed to be substituted by the following words:
“any business of manufacture or production of any article or thing, not being an article or thing specified in the list of the Eleventh Schedule”
The proposed change is to be made w.e.f. 1st April, 2010 and would hence apply for A.Y. 2010-11. The ‘Notes on Clauses’ of the proposed clause states as under:
The existing provision contained in sub-section (2AB) of section 35 provides for deduction of a sum equal to one and one half times of the expenditure so incurred to a company engaged in the business of biotechnology or in the business of manufacture or production of drugs, pharmaceuticals, electronic equipments, computers, telecommunication equipments, chemicals or any other article or thing notified by the Board and which has incurred expenditure (except land and building) on in-house scientific research and development facility approved by the prescribed authority.
It is proposed to extend the benefit of the said deduction to all businesses engaged in the manufacturing or production of article or thing except those specified in the Eleventh Schedule.
This amendment will take effect from 1st April, 2010 and will, accordingly, apply in relation to the assessment year 2010-11 and subsequent years.
Clause 13 of the Finance Bill proposes to insert new section 35AD in the Income-tax Act w.e.f. A.Y. 2010-11. The proposed section would read as under:
Section 35AD (1) An assessee shall be allowed a deduction in respect of the whole of any expenditure of capital nature incurred, wholly and exclusively, for the purposes of any specified business carried on by him during the previous year in which such expenditure is incurred by him.
(2) This section applies to the specified business which fulfils all the following conditions, namely:–
i) It is not set up by splitting up, or the reconstruction, of a business already in existence;
ii) It is not set up by the transfer to the specified business of machinery or plant previously used for any purpose;
iii) Where the business is of the nature referred to in sub-clause (iii) of clause (c) of sub-section (7), such business,-
a) is owned by a company formed and registered in India under the Companies Act, 1956 or by a consortium of such companies or by an authority or a Board or a corporation established or constituted under any Central or State Act;
b) has been approved by the Petroleum and Natural Gas Regulatory Board established under sub-section (1) of section 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006 and notified by the Central Government in the Official Gazette in this behalf;
c) has made not less than one-third of its pipeline capacity available for use on common carrier by any person other than the assessee or an associated person; and
d) fulfils any other condition as may be prescribed.
(3) The assessee shall not be allowed any deduction in respect of the specified business under the provisions of Chapter VIA under the heading “C.- Deductions in respect of certain incomes”.
(4) No deduction in respect of the expenditure referred to in sub-sevtion (1) shall be allowed to the assessee under any other section in any previous year or under this section in any other previous year.
(5) The provisions of this section shall apply to the specified business referred to in sub-section (2) if it commences its operations,–
(a) on or after the 1st day of April, 2007, where the specified business is in the nature of laying and operations a cross-country natural gas pipeline network for distribution, including storage facilities being an integral part of such network ; and
(b) on or after the 1st day of April, 2009, in all other cases not falling under clause (a).
(6) The assessee carrying on the business of the Nature referred to in clause (a) of sub-section (5) shall be allowed, in addition to deduction under sub-section (1), a further deduction in the previous year relevant to the assessment year beginning on the 1st day of April, 2010, of an amount in respect of capital nature incurred any earlier previous year, if
(a) the business referred to in clause (a) of sub-section (5) has commenced its operation at any time during the period beginning on or after the 1st day of April, 2007 and ending on the 31st day of March, 2009; and
(b) no deduction for such amount has been allowed or is allowable to the assessee in any earlier previous year.
(7) The provisions contained in sub-section (6) of section 80A and the provisions of sub-sections (7) and (10) of section 80-IA shall, so far as may be, apply to this section in respect of goods or services or assets held for the purposes of the specified business.
(8) For the purposes of this section, –
(a) an “associated person”, in relation to the assessee, means a person, –
(i) who participates, directly or indirectly, or through one or more intermediaries in the management or control or capital of the assessee;
(ii) who holds, directly or indirectly, shares carrying not less than twenty-six per cent, of the voting power in the capital of the assessee;
(iii) who appoints more than half of the Board of Directors or members of the ….
(iv) …………..
It is clear that the change in sec. 35(2AB) seeks to give impetus to scientific research, given the sorry state of affairs in our country vis-à-vis scientific research. And therefore the benefit of deduction w.r.t. scientific research is proposed to be extended to all businesses (except the ones specified in Eleventh Schedule). The deduction u/s. 35(2AB) will be equal to one and one half times of the expenditure incurred. In order to be eligible for deduction the expenditure must be incurred ‘on scientific research or in-house research and development facility’. The eligible expenditure would include capital expenditure (except land and building). So the expenditure on any other capital asset would be eligible. It follows that any expenditure incurred on acquisition of patents, copyrights, know-how (which is otherwise entitled for depreciation u/s. 32) would qualify for this deduction (provided of course it’s used for the purpose of scientific research and/or in-house research facility and a mere use in the business without any connection with scientific research activity will not qualify the expenditure).
The new section 35AC seeks to give a boost to the infrastructural facilities. It provides for 100% deduction of capital expenditure (except land, goodwill and financial instrument) for the purposes of specified business – it may be noted that unlike sec. 35 (2AB), capital expenditure on building is not disqualified for deduction u/s. 35AC. Specified business has been defined as:
(1) setting up and operating a cold chain facility,
(2) setting up and operating a warehouse facility for storage of agricultural produce and,
(3) laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network.
The businesses mentioned in (1) and (2) above will qualify for deduction if it commences its operations on or after 1st April 2009 and the business mentioned in (3) above will qualify if it commences its operations on or after 1st April. 2007. The specified business of cold chain facility has been given a broader scope by including in it facilities for storing agricultural produce, forest produce, meat & meat products, poultry, marine and dairy products, horticulture, floriculture, apiculture, processed food items. This is to give impetus to the cold chain facility which is facing a massive shortage in our country. But the specified business of warehousing is restricted to storage of agricultural produce only.
The provisions of sec. 80-IA(7) providing for furnishing, along with the return, auditor’s report have been imported in new sec. 35AC also. It is also permitted to use such plant & machinery in the specified business, which has been previously used provided the cost of such used plant & machinery does not exceed 20% of the value of the total plant & machinery used in such business. A specified business to which the deduction is allowed u/s. 35AC shall be debarred from claiming any deduction under Chapter VI-A.
The following are some of the issues, in the context of deduction u/s. 35, as laid down by the Courts/Tribunal.
1) It is not open to the Revenue to refuse deduction u/s. 35, on the ground that the asset was not used in the previous year in which capital expenditure was incurred – Gujarat Aluminium Extrusions (2003) 263 ITR 453 (Guj) ; Metallizing Equipment Co. Pvt. Ltd. (2005) 149 Taxman 43 (Jodh) (Mag). This is because, unlike u/s. 32, sec. 35(2AB) and the new sec. 35AC do not require that the asset should be actually used in the previous year-sec. 35(2AB) and sec. 35AC get attracted when expenditure is ‘incurred’.
2) Manufacture or production of computer software is an article or thing for the purpose of sec. 35(2AB) and hence shall qualify for the expenditure – TCIL Bell South Ltd. (2003) 130 Taxman 37 (Del) (Mag).
3) Where there is doubt of incurring of expenditure on scientific research and/or dispute on quantum of expenditure incurred on scientific research from out of common expenditure, the matter shall be referred to the prescribed authority. – Sanghi Medical Centre (2003) 126 Taxman 99 (Del) (Mag); F.C.S. International Mktg. Pvt. Ltd. (2006) 283 ITR 32 (P & H). This also the mandate of sub-section(3) of sec. 35.
4) What is ‘Business’ for the purpose of sec. 35 (2AB)? The word ‘business’ shall include consultancy services also and hence expenditure of scientific nature on feasibility report and other connected activities would be eligible for deduction u/s. 35 – CIT vs. U.P. Electronic Corporation (2005) 276 ITR 45 (All).
5) Even third party manufacture would be eligible for deduction. In this case the assessee developed a new technology product known as ‘Auto Attendant Voice Processing Systems’ but instead of manufacturing it, the assessee got the same manufactured from outside party and sold it under its brand name. It was held that deduction u/s. 35 is allowable – Anjaleem Enterprises Pvt. Ltd. (2005) 149 Taxman 9 (Ahd.) (Mag.)
6) For claiming deduction u/s. 35(1)(iv), it is not necessary that actual payment should have been made – Hero Honda Motors Ltd. (2005) 3 SOT 572 (Del).
7) It is not necessary that deduction can be allowed only for the period after the approval of the prescribed authority is obtained. In this case the assessee could obtain the approval only at the end of the financial year but claimed the deduction for the concerned assessment year. The Department contended that deduction can be permissible only for the period after the approval. This was rejected by the Court and it was held that once approval is obtained, it applies for the entire – Claris Life Sciences (2008) 174 Taxman 113 (Guj.).
8) What is ‘scientific research’? In a recent case before the Hon’ble Himachal Pradesh High Court the assessee incurred expenditure on importing a coffee vending machine for dismantling the same and studying its material with an intention to develop it indigenously. The assessee also engaged an engineer for the same. The Department contended that there was no scientific research. Rejecting the department’s contention and permitting the deduction, the Hon’ble Court held that any methodical or systematic investigation based on science into the study of any materials and sources, is a scientific research. – Engineering Innovation Ltd. (2009) 178 Taxman 237 (HP).
9) It has been held in a number of decisions that the requirement of filing Audit Report along with the return is directory and filing of audit report during the assessment proceedings is acceptable. In the following decisions it was held that deduction could not be denied even if the audit report was filed before the CIT(Appeals) – Trehan Enterprises 248 ITR 333 (J & K) ; Jayant Patel 248 ITR 199 (Mad) {Form Nos. 10C & 10D for sec.80J & sec. 80HH deduction filed before CIT(A)} ; Panacea Biotec Ltd. 121 TTJ (Del) 959. In one decision the Hon’ble Calcutta High Court held that audit report filed before the Tribunal should also be held to be sufficient compliance.
10) It is worth noting that recently the Hon’ble Mumbai Tribunal denied deduction u/s. 35(1)(iv) to an assesee since the assessee was not doing any other activity/business apart from scientific research. The Hon’ble Tribunal held that an assessee can be allowed deduction u/s. 35(1)(iv) only if the scientific expenditure was in relation to the business carried on by the assessee; i.e., there should be some activity (in the nature of a business activity) carried on by an assessee, in addition to the activity of scientific research, in order that the expenditure on scientific research would be eligible for deduction. In other words the business activity of the assessee should be independent/separate which would be feeded by the activity of scientific research. ( See: Ciba (I) Pvt. Ltd. (2008) 305 ITR (AT) 75 (Mum) & Ciba (I) Pvt. Ltd. (2009) 30 SOT 269 (Mum) ). In this case the assessee did not have any other activity (apart from scientific research) where the benefits of research activity could be used. This is because of the words “related to the business carried on by the assessee” included in sec. 35 (1) (iv). But these words “related to the business carried on by the assessee” are conspicuous by their absence in sec. 35 (2AB). Hence to the humble understanding of the author this requirement of the assessee being engaged in some business activity, in addition to the activity of scientific research and the activity of scientific research being in relation to the business activity of the assessee, is not necessary for claiming deduction u/s. 35(2AB).
Author:Mandar Vaidya, Advocate
Useful info.
Built up a Clear concept on Sec 35.