Claim for deduction as Bad debts

Assessee was a private company, consisting of two directors. Even though there was a partition effected between the brothers of one of the directors, the other brothers were demanding a share in properties. One of such properties, standing in the name of the Director, was purchased by the assessee company consisting of the director shareholders. The entire property was divided into three blocks. First two blocks were reserved for sale to outsiders, whereas third block was sold to members of Hindu Undivided Family (HUF) consisting of five Directors. Five flats were sought to be sold to the shareholders for a total sale consideration of ₹ 6.13 crore. Subsequently, a family settlement arrangement was arrived between members of HUF/their relatives and company and it was decided therein that assessee would waive right to recover dues of such consideration. According to assessee, said decision was taken in order to avoid future deadlock in the management of Company on account of any disputes arising between the family members who were also its shareholders. An Order was passed under Section 171, assessee filed its return claiming sale consideration waived off as bad debts. Assessing Officer opined that mere possibility that there could be future disputes / quarrels / differences between members of HUF, could not constitute a ground to hold that amount in question was bad debts. He, thus, rejected assessee’s claim. Tribunal, however, allowed claim raised by assessee. High Court by impugned order held that on facts, revenue could not contest assessee’s claim even after passing of order under section 171 and further, even otherwise. Since, only requirement of law was that amount should have been written off in books of account of assessee which was admittedly done.

The Commissioner (Appeals) considered the documents produced by the assessee. In terms of the partition effected, he held that the assessee came to know that the debts could not be recovered. That the family arrangement had been made only to avoid future disputes between the family members since some of them were directors of the assessee-company. He was of the view that a debt may become bad and irrecoverable either by an order of the Court of law or by the act of contracting parties.

Tribunal was justified in allowing assessee’s claim. Even SLP filed against impugned order was dismissed. Commissioner of Income Tax, Bangalore vs. Millennia Developers (P.) Ltd. [2018] 100 369

Amount debited in profit and loss account in respect of obsolete spares:

In this case, the assessee debited ₹ 92,66,211/- as obsolete stores and spares and other items written off in the books of account for the A.Y. 2009-10.

AO allowed the items written off while framing the scrutiny assessment under Section 143(3) of the Income-tax Act. The ld. Commissioner of Income Tax took order of the assessment under suo motu revision under Section 263(3) of the Act as the revisionary authority was of the view that the order passed by the AO was erroneous in so far as it was prejudicial to the interest of the revenue on account of an amount of ₹ 92,66,211/- written off in the profit and loss account relevant to A.Y. 2009-10 as obsolete spares and other items written off.

Assessee submitted with respect to obsolete spares and other items written off, the same was allowed by the AO after applying mind to the facts of case and after considering the details submitted by the assessee and the annual return filed by the assessee company and only thereafter allowed the deduction on obsolete spares and other items written off ₹ 92,66,211/- and therefore, it was submitted that order of the AO cannot be said to be prejudicial to the interest of the revenue and therefore, it was requested to withdraw the notice under Section 263 of the Act.

The ld. Commissioner, however, set aside the assessment order on the said ground and remanded the matter to the AO in the light of the observations made in the order.

The assessee preferred an appeal against the order under Section 263(3) before the Tribunal. It was vehemently submitted that the ld. Commissioner under Section 263(3) found that certain inquiry was not held/conducted by the AO while accepting the assessee’s claim of written off obsolete spares and stores of ₹ 92,66,211/- and therefore, the assessment order was found to be erroneous and prejudicial to the interest of the revenue and consequently the Ld. Commissioner set aside the order of the AO and remitted the matter to the AO to reframe the assessment.

As far as the Order passed by the AO allowing the assessee to debit ₹ 92,66,211/- or obsolete spares and stores and other items written off are concerned, the ld. Commissioner in exercise of the powers under Section 263 of the Act has set aside the order passed by the order by observing that the contents of the assessee needs detailed examination which was not done by the AO at the time of the assessment proceedings. However, at the time of passing of assessment order, the said issue was considered by the AO in detail and while passing the scrutiny assessment, even otherwise, it was not open for Commissioner to exercise the powers under Section 263(3) of the Act.

The ld. Tribunal has specifically observed after considering the companies policy and accounting treatment of obsolete spares and stores written off and consistent practice followed by the assessee, items of stores and spares having individual value of rupees 10,000 or less were debited only at the time of consumption. The learned Tribunal has rightly held that AO was justified in accepting claim of the assessee in debiting ₹ 92,66,211/- from the profit and loss account, hence, the learned Tribunal has observed that the order passed by the AO cannot be said to be prejudicial to the interest of the revenue. Therefore, Commissioner was not justified in interfering in the Order passed by the AO in exercise of the powers under Section 263(3) of the Act.

The Hon’ble Gujarat High Court held that no interference of the Court is called for no substantial question of law arises as proposed by the revenue and the revenue appeal was dismissed. Tax Appeal No. 99 of 2017. Case: Pr. Commissioner of Income Tax-Vadodara and Ors. vs. Gujarat State Fertilizer & Chemicals Ltd.. Gujarat High Court.

Rural Development Expenses

It was a case of reassessment in which the assessee has claimed rural development expenses as business expenditure. CIT(A) has given a finding of the fact, the impugned amount was not expended wholly and exclusively for the purpose of business. This finding of fact is not rebutted by the assessee. In absence of material proving the expenses incurred for the business of the assessee, same cannot be allowed under Section 37 of the Act. Hence, appeal was dismissed for the said grounds of appeal.

The Hon’ble Tribunal, Jaipur Bench dealt with the issue that afforestation, plantation & environment expenses have been incurred for maintaining the gardens at its corporate office, mining site office, obtaining environmental clearances, obtaining mining area lease, fees paid to pollution control board, assessing the quality of water etc. This expenditure, therefore, has been made out and expended wholly and exclusively for the purposes of assessee’s business. The above disallowance was therefore, directed to be deleted.

This finding of fact was not controverted by revenue by placing any contrary material on record. Therefore, the said appeal of the revenue was dismissed and did not interfere with the order of the learned CIT(A). Rajasthan State vs. Assistant Commissioner of Income Tax 188 TTJ (JP) 137.

Contribution to death relief fund for employees (DRFE)

Entitled to deductions, Income-tax Act, Section 37 and 40A:

Contribution to death relief fund is entitled to deduction under Section 37, as it is exclusively for the welfare of employees, so as to be eligible for deduction as having been incurred for the purpose of assessee’s business. It was also pointed out that deduction of similar labour welfare expenses have been expected by the High Court, so that a different view is not possible in this case. It was in this view, the decision taken by the Tribunal affirming the view of the authorities that such deduction is barred under Section 40A(ix) was found to be not correct in light of law, i.e., deductible under Section 37 of the Income-tax Act – Madura Coats Pvt. Ltd. vs. Dy. CIT [2019] 417 ITR 115 (Madras).

Would expenditure incurred on upgradation of existing facilities constitute capital expenditure?

Facts of the case:

The assessee is the Cricket Club of India who had filed the return of income for assessment year 2007-08 while scrutinising the return of income. Assessing Officer noticed that the assessee had incurred expenditure of ₹ 3.91 crores in upgradation of cricket stadium and various other incidental requirements. The Assessing Officer was of the opinion that the expenditure incurred was capital in nature and, therefore disallowed the same. The assessee carried the matter in appeal. CIT(A) allowed part of the claim and restricted the disallowance to ₹ 1.85 crore. Both the sides carried the matter in appeal before the Tribunal. The Tribunal allowed the assessee’s appeal and dismissed the revenue’s appeal upon which the present appeal has been filed.

Perusal of the materials on record and in particular the impugned judgment of the Tribunal would show that the Respondent- assessee had organised several matches of ICC Champion’s Trophy. In order to do so, the assessee had taken upgradation of the stadium which included arranging the facility for training and warm up areas, providing passages, walk ways, staircase etc., improving the media facility, installation of electronic score board and other similar facilities. The Board had also expended in providing proper security and car parking facilities. It was in this background, the Tribunal had held that the expenditure was revenue in nature.

Looking to the nature of expenditure, it can be seen that the assessee did not create a new asset or create a source of enduring benefit. Essentially, the expenditure was for upgradation of the existing facilities. Appeal of Department was dismissed. – Principal CIT-1 vs. Cricket Club of India [2019] 265 Taxmann 95 (Bombay High Court).

Expenditure incurred to increase efficiency without enhancing of Plant & Machinery

Large expenses was spent on major repairs and maintenance of machinery but no enduring benefit was carried out of said expenses incurred by assessee was to be allowed as business expenditure. There was no enhancement in the capacity of Plant and Machinery or increase in the efficiency and no new equipment was purchased, since no enduring benefit was created by the assessee out of the said expenses. The same was revenue expenditure and was allowed. – Dy. CIT vs. Kalyanpur Cement Ltd. 65 ITD 637 (Kol.)

Expenditure incurred was only to preserve and maintain the existing asset without any enduring advantage, same could not be treated as capital expenditure

In this case, the assessee was engaged in power generation, incurred expenditure towards replacement or various components in boilers and BWE and claimed as revenue expenditure.

Assessing Officer held expenses to be capital in nature on the ground that they were incurred after expiry of life span of machinery giving the assessee an enduring advantage. There was a clear finding in order of assessment, first option was to install a new plant which would have cost ₹ 4.5 crore per MW with a longer gestation period and second option was to go in for life extension programme at a cost of ₹ 0.44 crore per MW with a shorter gestation period. The assessee had gone for a cheaper option.

Madras High Court held that the expenditure incurred was only to preserve and maintain existing assets without any enduring advantage, therefore, same could not be treated as capital expenditure.

The matter came up before the Tribunal on the issue whether reinsurance or a prohibited business for insurance companies.

The issue had been remanded by the Tribunal to the AO for fresh consideration. The Hon’ble Madras High Court held that on admitted facts that materials produced were not new and the applicability of amended provisions did not require further probing of facts. The Order of the remand was not justified.

The High Court found that the remand was unjustified in Cholamandalam General Insurance Co. vs. Assistant / Dy. CIT 357 ITR 597 (Mad.) and the matter was remanded back to the Tribunal while pointing out that the Income Tax by amendments with effect from 1st April, 1961 permitted reinsurance and recognized by the regulatory and development authority and accordingly decision of Tribunal in the DCIT vs. Cholamandalam Insurance General Insurance Co. Ltd. [2018] 12 ITR Tribunal OL 540 (Chennai) was set aside – Cholamandalam Insurance Co. Ltd. vs. Dy. CIT LTU, 411 ITR 386 (Mad.)

Prior Period Expenses

Assessment of income of prior period – Section 37

There was a controversy as to the deductibility of prior period expenses claimed during the year.

As long as the expenses were incurred during the year, there can be no further question as to whether the transaction concerned had taken place during the year. There was no burden on the assessee to demonstrate that certain expenses, where it is incurred during the year also relates to the same year, as long as the liability has been incurred during the year, following the reasoning not only in Circular No. 621, 195 ITR (ST) 154, but also in CIT vs. Shri Ram Honda Power Equipment 289 ITR 475 (Delhi)CIT vs. Exon Mobile Lubricants Pvt. Ltd. 328 ITR 17 Delhi & CIT vs. Excel Industries Ltd. 358 ITR 295 (SC). The said prior period expenditure was allowed – Principal CIT vs. Dishman Pharmaceuticals & Chemicals Ltd. [2019] 417 ITR 373 (Guj)

Section 37(1) – Business Expenditure

Capital or Revenue – Assessee wrongly entered the amount as capital in nature in the books – But in its return of income, rightly claimed it as revenue expenditure – Merely because a different treatment was given in books of account could not be a factor which would deprive the assessee from claiming entire expenditure as a revenue expenditure.

The assessee company was engaged in the business of organised retail. Its main business was sourcing and selling fruits, vegetables, food articles, groceries, fast moving goods and other goods of daily use and provisions of various related services as a neighbourhood convenience store. However, in order to expand business, the assessee was setting up new stores. In its return of income, the expenditure incurred for setting up new stores had been claimed as revenue expenditure to the extent the expenditure was revenue in nature and where capital expenditure was incurred, the same was not claimed as revenue expenditure. However, the assessee in its books of account showed the entire expenditure, i.e., even the expenditure which was claimed in the income tax return as revenue expenditure, as capital expenditure. The AO disallowed the same on the ground that the assessee had itself capitalised the same under the head ‘Project Development Expenditure’.

The CIT(A) held that since the assessee himself had claimed that these expenses pertained to a project which had not been implemented, therefore, it could not be allowed as revenue expenditure and confirmed the order of the AO.

Being aggrieved with this order, the assessee filed an appeal before the Tribunal. The Tribunal held that all the expenses were purely revenue in nature. None of the expenses pertained to acquisition of any capital asset. It was also well settled law that ‘normally’, the manner of accounting shall not determine the taxability of income or allowability of any expenditure. The taxability of income and allowability of an expense shall be determined on the basis of the provisions of the income-tax law as contained in the Income-tax Act, 1961 and as explained by various courts from time-to-time. It was further noticed that nothing had been brought out by the lower authorities to show that any of these expenses were capital in nature, except the fact that the assessee had debited the same under the head ‘Project Development Expenditure’. The assessment of the return had to be made on the basis of the return filed by the assessee supported with accounts. While examining the accounts, the return could not be ignored. The return had to take precedence over the accounts in respect of legal claims. The accounts had to be seen only to verify the facts. The admissibility of a claim or otherwise should be primarily and predominantly on the basis of claims made by the assessee in the return of income, unless the assessee claimed otherwise subsequently during the course of assessment proceedings.

These expenses were revenue in nature and should be allowed as such. There was no estoppel against the statute and the Act enabled and entitled the assessee to claim the entire expenditure in the manner it could be claimed under the law.

Being aggrieved with the order of the ITAT, the Revenue field an appeal before High Court. The High Court relied on the case of Reliance Footprint Ltd. being Income Tax Appeal No. 948/2014. The Court had, vide order dated 5th July, 2017, dismissed the above appeal filed by the Revenue on an identical question as framed herein. Revenue agreed with the position that the decision of the Court in Reliance Footprint Ltd. (Supra) would cover the issue arising herein. In the above view, the appeal was, therefore, dismissed. – Reliance Fresh Limited vs. ACIT 7(2), ITA No. 1661/Mum/2013, A.Y. 2008-09

Business Expenditure

Agreement with the State Government to construct houses for poor people affected by floods:

In this case, assessee was carrying on the business of iron ore and also trading in iron ore. Thus, day in and day out the assessee would be approaching the appropriate Government and its authorities for grant of permits, licences and as such the assessee in its wisdom and as a prudent business decision had entered into a memorandum of understanding with the Government of Karnataka and incurred the expenditure towards construction of houses for the needy persons, not only as a social responsibility but also keeping in mind the goodwill and benefit it would yield in the long run in earning profit which was the ultimate object of conducting business and as such, expenditure incurred by the assessee would be in the realm of “business expenditure”. The amounts were deductible – Kanhaiyalal Dudheria vs. Joint Commissioner of Income-tax & Anr. [2019] 418 ITR (Karn.), 310 CTR 617 (Karn.)

Business Expenditure – Capital or Revenue Expenditure

The assessee was in the business of developing, maintaining and operating bus queue shelters, metro stations and highways. It had entered into a concessionaire agreement with the Delhi Transport Corporation for setting up 400 bus shelters on build, operate and transfer basis. The assessee was to construct, operate and maintain the shelters for ten years, after which the shelters were to be handed over to the Corporation. According to the agreement the assessee had to pay the Corporation ₹ 4.09 crore per month. In return, the assessee was free to earn revenue through advertising to be displayed on the bus shelters. The assessee was also required to furnish two bank guarantees of ₹ 1.00 crore and ₹ 1.5 crore to the Corporation as performance security for construction and for operation and maintenance of the bus shelters and payment of concessionaire fee respectively. When the Corporation invoked the bank guarantee, the assessee approached the Delhi High Court which passed a restraint order against encashment. However, the stay order was vacated and the Corporation was permitted to encash the bank guarantee. As the assessee had obtained stay, it was directed to pay interest at the rate of 9% per annum till the date of payment. For the assessment year 2009-10, the Assessing Officer disallowed a sum of ₹ 2,08,92,603/- claimed as capital loss suffered by the assessee for failure to perform its part of the concessionaire agreement with the Corporation and the interest on late payment as capital expenditure and not revenue expenditure. The disallowance was upheld by the Commissioner (Appeals). The Tribunal reversed the findings and held that the addition was not justified as it was a revenue expenditure – [2019] 417 ITR 162 (Delhi) Principal Commr. of Income-tax vs. Green Delhi BQS Ltd.

Business Expenditure

Section 37(1) of Income-tax Act, 1961 – Where assessee company, engaged in business of construction and sale of residential and commercial building complexes, sold a building which was under construction at time of sale and incurred expenditure for completing its construction during financial year subsequent to sale of building, such expenditure was liable for deduction under Section 37(1).

The Commissioner (Appeals) held that in a situation where at the time of assessment the building remains incomplete, estimated future expenditure to be incurred was also considered along with the expenditure already incurred and was taken as cost relatable to the total saleable area, i.e., saleable area already built and the saleable area to be built in future, for arriving at the estimated cost of construction per square foot (sq.ft.). Therefore, the contentions of the assessee were accepted and it was held that the AO was not justified in not taking the value of building work-in-progress during the financial years 2009-10 and 2010-11 for working out the cost per square feet. It was directed that the cost per square feet would be taken as total expenditure incurred in construction, divided by the total saleable area, for the purpose of working out the profit from the sale of commercial area. The Tribunal upheld the decision of the Commissioner (Appeals).

The Revenue filed an appeal before the High Court and contended that the claim for deduction of future expenses made by the assessee could not be allowed. It contended that there was a distinction between the amount spent to pay off an actual liability that would be incurred in future which was only contingent. It was contended that the former was deductible but not the latter.

The Kerala High Court upheld the decision of the Tribunal and held as under:

(i) The dispute raised by the Revenue is only with regard to the deduction claimed by the assessee in respect of the expenses incurred in future, that is, after the sale of the building, during the subsequent financial years and not in respect of the expenses incurred by it during the relevant financial year. Section 37 is a residuary section for allowability of business expenditure.

(ii) The expression ‘profits and gains” has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom – whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. It is the meaning of the word ‘profits’ in relation to any trade or business. Whether there be such a thing as profit or gain can only be ascertained by setting against the receipts the expenditure or obligations to which they have given rise.

(iii) ‘Expenditure’ is not necessarily confined to the money which has been actually paid out and it covers a liability which has accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure. It also covers a liability which the assessee has incurred in praesenti although it is payable in futuro.

(iv) In order to claim deduction of business expenditure, it is not necessary that the amount has been actually paid or expended during the relevant accounting year itself and it is sufficient that the liability for payment had incurred or accrued during the relevant accounting year and the actual payment of amount or discharge of liability may occur in future and what is crucial is the accrual of liability for payment or expenditure during the relevant accounting year. But a contingent liability that may arise in future cannot be treated as expenditure. Thus, the substantial question of law is answered in favour of the assessee and against the revenue – CIT vs. Oberon Edifices & Estates (P) Ltd. [2019] 110 305 (Ker.) dated 5th September, 2019

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