Weighted deduction available on all expenditure incurred on in-house research & development facility

Pharmanza Herbal Private Ltd. Vs DCIT (ITAT Ahmedabad)

ITAT Ahmedabad held that assessee is entitled to claim weighted deduction on all expenditure incurred by it, on in-house research & development facility. Accordingly, restricting claim of weighted deduction u/s 35(2AB) to the extent approved by the prescribed authority i.e. DSIR unjustified.

Facts- In the present case, the assessee briefly pointed out that in terms of section 35(2AB) of the Act the assessee is entitled to weighted deduction at the rate of 200% on account of expenditure incurred on scientific research in in-house research and development facility, which facility is approved by the prescribed authority, being Department of Scientific & Industrial Research (DSIR). The assessee claimed weighted deduction of expenditure incurred on scientific research as claimed in its profits and loss account, but the Department restricted the assessee’s claim of weighted deduction to the extent of expenditure which was approved by the prescribed authority i.e. DSIR in Form 3CL. Thus, alleged excess deduction claimed by the assessee was disallowed.

Conclusion- Held that amendment to section35(2AB) by the Finance Act, 2015 w.e.f. 1.4.2016. Since these assessments are prior to 1.4.2016, the amendment to section 35(2AB)) are not applicable to the same and in terms of un-amended provisions of section 35(2AB) of the Act, since we have held above that the prescribed authority was not required in law to quantify the amount of expenditure incurred on in-house research and development facility, such quantification, if any done by the prescribed authority in Form No.3CL was not required to be taken cognizance of by the Revenue authorities and the assessee is entitled to claim weighted deduction on all expenditure incurred by it, on in-house research & development facility. Therefore, we agree with the contentions of the ld.counsel for the assessee, before us that in the impugned year involved before us, the Revenue has erred in restricting the claim of weighted deduction under section 35(2AB) of the Act to the extent approved by the prescribed authority i.e. DSIR.

FULL TEXT OF THE ORDER OF ITAT AHMEDABAD

Present two appeals have been filed by the assessee against orders passed by the ld.Commissioner of Income Tax(Appeals), National Faceless Appeal Centre (NFAC), Delhi[hereinafter referred to as “Ld.CIT(A)”] of even dated 31.10.2022 under section 250 of the Income Tax Act, 1961 (hereinafter referred to as the “Act’ for short) for the above two assessment years.

2. It was common ground that the issue raised in both the appeals was identical, relating to the disallowance of claim of weighted deduction u/s section 35(2AB) of the Act. Since identical grounds have been raised in both the appeals before us, the grounds raised in ITA No.468/Ahd/2022 for Asst.Year 2014-15 are being reproduced for reference as under:

1. In law and in the facts and circumstances of the appellant’s case, the Ld. CIT (A) has erred in confirming the disallowance u/s. 35 (2AB) to the extent of Rs.27,93,980/-.

2. In law and in the facts and circumstances of the Appellant’s case, the Ld. CIT ought to have appreciated that the total R&D expenditure incurred by the appellant was of Rs.42,42,490/- and accordingly, the deduction available to the appellant u/s.35 (2AB) was of Rs.84,84,980/-. He has failed to appreciate that as held by the different decisions of ITAT, Ahmedabad and decision of Gujarat High Court cited before him, once the R&D facility is approved by DSIR, the entire expenditure incurred on such facility is eligible for deduction u/s. 35 (2AB). The department has not disputed the incurring of expenditure as shown by the appellant on R&D facility and therefore, there is no question of restricting the amount eligible for deduction.

3. The Hon’ble ITAT may please direct for allowing the entire deduction as claimed by the appellant.

4. The appellant craves leave to add to amend or to raise any further grounds of appeal as case may arise

3. The ld.counsel for the assessee submitted that the facts and the basis for disallowance by the Department are identical and his arguments therefore in both the years were the same. The ld.DR fairly agreed to the same. In view of the same, we take up both the appeals together for adjudication and dispose them by way of this common order.

4. Drawing our attention to the facts of the case, the ld.counsel for the assessee briefly pointed out that in terms of section 35(2AB) of the Act the assessee is entitled to weighted deduction at the rate of 200% on account of expenditure incurred on scientific research in in-house research and development facility, which facility is approved by the prescribed authority, being Department of Scientific & Industrial Research (“DSIR” for short). He contended that for both the years the assessee claimed weighted deduction of expenditure incurred on scientific research as claimed in its profits and loss account, but the Department restricted the assessee’s claim of weighted deduction to the extent of expenditure which was approved by the prescribed authority i.e. DSIR in Form 3CL. Thus, alleged excess deduction claimed by the assessee, which in the AY 2014-15 amounted to Rs.23.45 lakhs and in AY 2015-16 amounted to Rs.27.31 lakhs was disallowed. The excess having been calculated in each year as under:

5. Arguments of the ld.counsel for the assessee before us was that the issue already stood covered in favour of the assessee by various judgments of the ITAT holding that DSIR was not empowered to give any approval for expenditure incurred on in-house scientific research prior to 1.4.2016, when Form No.3CL issued by DSIR was only for the purpose of certifying that the assessee was approved to carry out in-house research and development, and that only subsequent to the amendment made in the Rule i.e. Rule-6 of the Income Tax Rules, 1962 and in Form No.3CL that the requirement of certifying the amount of expenditure incurred by the assessee on in-house research development, was also required to be mentioned in Form No.3CL by DSIR; that the assessee’s case pertained to the period prior to 1.4.2016, and therefore quantum approved by DSIR of expenditure incurred by the assessee on in-house research and development as mentioned in Form No.3CL was of no relevance, and Form No.3CL was to be read only to the extent of DSIR approving the fact that the assesseehad facility for carrying on in-house research and development. In support of his contention, he placed before us the following decisions:

i) ACIT Vs. M/s. Crompton Greaves Ltd., 5295 & 5390/Mum/2017 dated 27.9.2019;

ii) Crest Composites & Plastics P. Ltd. Vs. DCIT, 28/Ahd/2017 dated 31.8.2021;

iii) Sun Pharmaceutical Industries Vs. Pr.CIT, 1417/Ahd/2016 dated 17.5.2019;

6. The ld.DR, on the other hand, pointed out that the interpretation by the various decisions of the ITAT that the purpose of Form No.3CL prior to 1.4.2016 was only to certify that the assessee was approved as having an in-house research and development facility,was misplaced, because, certification of approval of facility was required tobe given by DSIR in a separate Form i.e. Form No.3CM; that there cannot be requirement of furnishing two forms by the prescribed authority, i.e. DSIR, for the same purpose i.e. both Form No.3CM and 3CL be issued for approving inhouse research and development facility; that Form No.3CL has to be read along with requirement of section 35(2AB) sub-section 3 where conditions for entitling weighted deduction in terms of sub- section (3) of section 35(2AB) requires assesses to enter into an agreement with the prescribed authority for cooperation in such research and development facility and for the audit of the accounts maintained for that facility; meaning thereby, the assessee has to get its accounts audited and DSIR is thereafter required to be mention the amounts found spent by the assessee on in-house research and development facility in Form No.3CL.

7. We have heard both the parties; carefully gone through the orders of the authority below and also decisions cited before us. The issue in dispute before us is vis a vis claim of weighted deduction at the rate of 200% of the expenditure incurred on in-house research and development activity, as allowed by section 35(2AB) of the Act.The Revenue restricting the assessee’s claim to the extent approved by the prescribed authority in Form No.3CL, while the assessee claiming weighted deduction on the entire amount of research and development expenditure debited to its P&L account.

8. We have gone through the relevant provision of law and the relevant Rules & forms prescribed thereto for executing the provision of law in this regard, and we agree with the Ld.Counsel for the assessee that for the impugned years before us ,i.e A.Y 14-15 & 15-16,the prescribed authority, DSIR,- was not required to certify in Form 3CL the quantum of expenditure incurred by assesses on inhouse research and development eligible for weighted deduction/s 35(2AB) of the Act. That therefore the certification by the DSIR of the quantum of expenditure on inhouse research and development in the present case in Form 3CL would not impinge on assesses claim of expenditure incurred as per Profit and Loss account. The detailed reasons are set out below.

9. Sub Section (1), (3) & (4) of section 35(2AB) prescribe the conditions subject to fulfilment of which the assessee is entitled to weighted deduction under the section. The said sub sections applicable for the impugned years before us read as under:

35(2AB)(1) Where a company engaged in the business of bio-technology or in 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] incurs any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the prescribed authority, then, there shall be allowed a deduction of a sum equal to [two] times of the expenditure so incurred.

…..                         …..                       ……                       ….                       ….                       ….

(3) No company shall be entitled for deduction under clause (1) unless it enters into an agreement with the prescribed authority for co-operation in such research and development facility and [fulfils such conditions with regard to maintenance of accounts and audit thereof and furnishing of reports in such manner as may be prescribed].

(4) The prescribed authority shall submit its report in relation to the approval of the said facility to the [Principal Chief Commissioner or Chief Commissioner or] [Principal Director General or] Director General in such form and within such time as may be prescribed.”

10. As is evident from a bare perusal of the above the assessee is entitled to weighted deduction on capital and revenue expenditure on in-house research and development facility subject to the condition that :

• its in-house research and development facility is approved by the prescribed authority,
• the assessee enters into an agreement with the prescribed authority for cooperation in such research and development facility and for cooperation in audit and accounts of the said facility and
• The report of the prescribed authority granting approval is submitted to a designated officer of the Department in prescribed form within a prescribed period of time.

Rule 6 of the Income Tax Rules, 1962, lists all specifications required for the section to be workable.

Rule 6(1B) specifies the prescribed authority for section 35(2AB) as being the DSIR, while sub Rule(4) prescribes the application to be made for seeking approval to DSIR in Form 3CK, sub-Rule (5A) in turn prescribes the relevant Form for granting approval to the assessee as Form 3CM.

11. The relevant Rules 6(1B) (4) & (5A) are reproduced hereunder for clarity.

6. ….

[(1B) For the purposes of sub-section (2AB) of section 35, the prescribed authority shall be the Secretary, Department of Scientific and Industrial Research.]

[(4) The application required to be furnished by a company under sub-section (2AB) of section 35 shall be in Form No. 3CK.]

….                             ……                           …..

[(5A) The prescribed authority shall, if he is satisfied that the conditions provided in this rule and in sub-section (2AB) of section 35 of the Act are fulfilled, pass an order in writing in Form No. 3CM.”

Rule 6(7A) prescribes Form 3CL for obtaining report of the prescribed authority in relation to the approval to be furnished in Form 3CL to the Director General (Income Tax Exemptions) and specifies time limit for furnishing this report as within 60 days of granting approval. This sub Rule also prescribes conditions subject to which approval is to be granted by DSIR. Rule 6(7A) reads as under:

6[(7A) Approval of expenditure incurred on in-house research and development facility by a company under sub-section (2AB) of section 35 shall be subject to following conditions, namely :—

(a) The facility should not relate purely to market research, sales promotion, quality control, testing, commercial production, style changes, routinedata collection or activities of a like nature;

(b) The prescribed authority shall submit its report in relation to approval of in-house Research and Development facility in Form N 3CL to the Director General (Income-tax Exemptions) within sixty d- ; of its granting approval;

(c) The company shall maintain a separate account for each approved facility; which shall be audited annually and a copy thereof shall be furnished to the Secretary, Department of Scientific and Industry Research by 31st day of October of each succeeding year.

Explanation: For the purposes of this sub-rule the expression “audited” means the audit of accounts by an accountant, as defined in : Explanation below sub-section (2) of section 288 of the Income-tax Act, 1961;

(d) Assets acquired in respect of development of scientific research and development facility shall not be disposed of without the approval of;: Secretary, Department of Scientific and Industrial Research.]

12. As is evident from Rule 6(7A), the prescribed authority is required to submit its report in relation to the approval granted in Form 3CL. And this report is to be submitted within 60 days of granting approval. Form 3CM on the other hand is the form prescribing the format in which order of DSIR granting approval.

Clearly therefore the scope of Form 3CL and Form 3CM are different and not overlapping as contended by the Revenue before us.

Further Rule 6(7A) requires assesses to submit their audited accounts relating to each approved facility to the prescribed authority, DSIR, each year.

Thus as per the provisions of law and Rules also there is no requirement for DSIR certifying the quantum of expenditure incurred by assesses on in-house research and development. The only requirement is for assesses to submit their audited accounts of the approved facility to DSIR every year. Form 3CL is only for submitting report of granting approval by DSIR, the report to be submitted to the designated Revenue authority within 60 days of granting approval.

The contents of Form 3CL also reveal no requirement of certification of quantum of expenditure incurred on inhouse research and development.

FORM NO. 3CL

Report to be submitted by the prescribed authority to the Director General (Income Tax Exemptions) under section 35(2AB) of the Income-tax Act, 1961

1. Name and Address of the registered office of the company including Telex/Fax/Phone numbers

2. Permanent Account Number (PAN) of the company

Name and designation of the Principal Officer of the company

3. Nature and Business/activity of the company

Manufacture/production of-

Drugs

Pharmaceuticals

Electronic Equipments

Computers

Telecommunication Equipments

Chemicals

Any other article or thing notified under sub-section (2AB) of section 35 (please specify)

4. Annual production of the eligible products of the company during the past three years.

5. Proposed objectives of scientific research contemplated by the company.

6. Whether the nature of the business is related to the proposed objectives of the scientific research contemplated by the company.

7. Details of the nature of existing in-house Research and

8. Development facilities specifying whether the in-house Research and Development facility is adequate for carrying out scientific research.

9. Whether recognition granted to the in-house Research and

At point No.9 DSIR is required to report the total cost of in house research facility ,giving break up of expenditure on land and building and at Pt. No.10 it is required to report whether agreement for cooperation in the facility and for audit of accounts is entered into with the concerned entity. There is no requirement for reporting expenditure incurred year to year on research and development.

13. A conjoint reading of all the above reveals that as per the applicable provisions of law there was no requirement for the prescribed authority to certify the quantum of expenditure incurred by assesses on inhouse research and development activity. That the only reporting requirement in Form 3CL by the prescribed authority was with regard to the approval granted by it recognizing the inhouse research and development facility. For the quantum of expenditure eligible for weighted deduction as per section 35(2AB) of the Act, the only requirement prescribed by law was of entering into agreement with the prescribed authority for cooperation in audit of accounts of the facility, the Rules requiring separate accounts to be maintained of the facility which also were required to be audited by an accountant and report submitted in this regard to the prescribed authority every year,.

14. By Finance Act, 2015, sub-section (2) and (3) of section 35(2AB) was amended w.e.f. 1.4.2016 and the earlier requirement of entering into an agreement with the DSIR of audit of accounts was substituted with the assessee “fulfilling” such conditions with regard to the maintains of accounts and audit thereto, and furnish a report in such manner as may be prescribed. The amended sub-section (3) to section 35(2AB) reads as under:

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(3) No company shall be entitled for deduction under clause (1) unless it enters into an agreement with the prescribed authority for co-operation in such research and development facility and fulfils such conditions with regard to maintenance of accounts and audit thereof and furnishing of reports in such manner as may be prescribed.

15. As a consequence to this amendment, Rule 6(7A) was also amended specifically requiring the prescribed authority to quantify expenditure incurred on in-house research and development eligible for weighted deduction in terms of section 35(2AB) of the Act in Form 3CL, the report of which is required to be submitted within 120 days of receipt of audit report of the accounts relating to the facility. The amended Rule 6(7A) reads as under:

“6[(7A) Approval of expenditure incurred on in-house research and development facility by a company under sub-section (2AB) of section 35 shall be subject to the following conditions, namely :—

(a) The facility should not relate purely to market research, sales promotion, quality control, testing, commercial production, style changes, routine data collection or activities of a like nature;

[(b) The prescribed authority shall furnish electronically its report,—

(i) in relation to the approval of in-house research and development facility in Part A of Form No.3CL;

(ii) quantifying the expenditure incurred on in-house research and development facility by the company during the previous year and eligible for weighted deduction under sub-section (2AB) of section 35 of the Act in Part B of Form No.3CL;

(ba) The report in Form No.3CL referred to in clause (b) shall be furnished electronically by the prescribed authority to the Principal Chief Commissioner of Income-tax or Chief Commissioner of Income-tax or Principal Director General of Income-tax or Director General of Income-tax having jurisdiction over such company within one hundred and twenty days,—

(i) of the grant of the approval, in a case referred to in sub-clause (i) of clause (b);

(ii) of the submission of the audit report, in a case referred to in sub-clause (ii) of clause (b);]

(c) The company shall maintain a separate account for each approved facility; which shall be
audited annually and [a report of audit in Form No.3CLA shall be furnished electronically to the Secretary, Department of Scientific and Industrial Research on or before the due date specified in Explanation 2 to sub-section (1) of section 139 of the Act for furnishing the return of income, for each succeeding year].

Explanation : For the purposes of this sub-rule the expression “audited” means the audit of accounts by an accountant, as defined in the Explanation below sub-section (2) of section 288 of the Income-tax Act, 1961;

(d) Assets acquired in respect of development of scientific research and development facility shall not be disposed of without the approval of the Secretary, Department of Scientific and Industrial Research.]

16. Form no.3CL was accordingly amended requiring reporting of expenditure incurred on inhouse research and development as under:

16. Form 3CK being the agreement entered by assesses with DSIR for cooperation in research activity and audit of accounts also underwent change requiring assesses to report quantum of expenditure incurred every year on research and development activity as per audit accounts.

17. It is amply evident from the above, that w.e.f. 1-4-2016, the requirement of law underwent a change to the effect that on entering into agreement with DSIR in Form no.3CK, the assessee was required to submit information of its expenditure incurred in-house research and development facility on land, building, capital and revenue expenditure, every year to the prescribed authority in Annexure-2 of Form no.3CK and prescribed authority was required to quantify the expenditure eligible for weighted deduction in Part-B of the Form No.3CL.

18. What derives from the above, therefore, is that consequent to amendment to section35(2AB) by the Finance Act, 2015 w.e.f. 1.4.2016, requirement of law was that the prescribed authority had to quantify the quantum of eligible expenditure incurred on in-house research and development facility by the assessee. But prior to that there was no such requirement inlaw and the prescribed authority was the only required to grant approval to the in-house research & development activity.

19. The impugned assessment year before are Asst.Year 2014-15 & 2015-16. Since these assessments are prior to 1.4.2016, the amendment to section 35(2AB)) are not applicable to the same and in terms of un-amended provisions of section 35(2AB) of the Act, since we have held above that the prescribed authority was not required in law to quantify the amount of expenditure incurred on in-house research and development facility, such quantification, if any done by the prescribed authority in Form No.3CL was not required to be taken cognizance of by the Revenue authorities and the assessee is entitled to claim weighted deduction on all expenditure incurred by it, on in-house research & development facility. Therefore, we agree with the contentions of the ld.counsel for the assessee, before us that in the impugned year involved before us, the Revenue has erred in restricting the claim of weighted deduction under section 35(2AB) of the Act to the extent approved by the prescribed authority i.e. DSIR.

In view of the above, we direct the AO to allow full benefit of claim of weighted deduction to the assessee to the extent claimed in the P&L accounts and the disallowance made, therefore, in both the years amounting to Rs.23,45,490/- and Rs.27,31,502/- under section 35(2AB) is directed to be deleted.

20. In the result, the appeal of the assessee is allowed.

Order pronounced in the Court on 23rd August, 2023 at Ahmedabad.