INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH "E": NEW DELHI
BEFORE SHRI S.V.MEHROTRA, ACCOUNTANT MEMBER
AND
SHRI A. T. VARKEY, JUDICIAL MEMBER
ITA No. 1718/Del/2012
(Assessment Year: 2008-09)
Orient Craft Ltd., ACIT
F-8, Okhla Industrial Area, Circle-13(1),
Phase-I, New Delhi Vs. New Delhi
PAN:AAACOO0068M
(Assessee) (Respondent)
ITA No. 2550/Del/2012
(Assessment Year: 2008-09)
ACIT Orient Craft Ltd.,
Circle-13(1), F-8, Okhla Industrial Area,
Room No.406, C.R. Building, Vs. Phase-I, New Delhi
I.P. Estate, New Delhi PAN:AAACOO0068M
(Assessee) (Respondent)
Assessee by : Sh. Salil Agarwal, Adv
Sh. Sailesh Gupta, Adv
Respondent by : P Damkanunjna, Sr. DR
Date of Hearing 12.02.2015
Date of pronouncement 30.04.2015
ORDER
PER A. T. VARKEY, JUDICIAL MEMBER
This is an appeal preferred by the assessee and cross appeal filed by
the revenue against the order of the ld CIT(A)-XVI, New Delhi dated
22.12.2011 for the Assessment Year 2008-09.
2. The grounds of appeal of the assessee are as follows:-
"1. That the order passed by lower authorities is bad in law and against the
facts and circumstances of case.
2. That ld CIT(A) has erred in law in mechanically applying Section 14A
read with Rule 8D(2)(iii) by sustaining the additions of Rs.18,02,321/-
arbitrarily and without any justification.
3. It is contended that the provisions of Rule 8D are not applicable.
4. The above grounds of appeal are independent and without prejudice
to one and another."
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2. The grounds of appeal raised by the revenue are as follows:-
"1. Whether on the facts and circumstances of the case, the Ld. CIT(A)
has erred in restricting the disallowance u/s 14A to Rs18,02,321/- from
Rs.1,45,72,152/- and not applying Rule 8D of the Income Tax Rules
which is mandatory from A.Y.2008-09.
2. Whether on the facts and circumstances of the case, the Ld. CIT(A) has
erred in not providing any finding that there is no expenditure by way
of interest which is not directly attributable to any particular income or
receipt (as referred to in Rule 8D(2)(ii).
3. Whether on the facts and circumstances of the case, the Ld. CIT(A) has
erred in not accepting the fact that the sample and design created by
the assessee and supplied to its potential buyers created a market and
goodwill for the assessee which has and enduring benefit in soliciting
customers for the assessee not only during the financial year but also
on a longer basis.
4. Whether on the facts and circumstances of the case, the Ld. CIT(A) has
erred in deleting the addition of Rs.7,91,00,000/- made by the AO on
account of Product development expenses. The benefit of the product
development expenses of the company is derived by the company
over a period of three years as per the judgement of the Hon'ble Apex
Court in Madras Industrial Investment Corporation Ltd. Vs. CIT 225 ITR
802."
3. The sole ground raised by assessee is regarding disallowance u/s 14A of
the Income Tax Act, 1961(herein after `the Act') in respect to relief partly
given by the ld CIT(A). Ground No.1 and 2 of revenue is regarding
disallowance partly deleted by the ld CIT(A) on this issue. Since the effective
sole ground of the assessee and ground Nos.1 and 2 of the revenue is the
same, we propose to dispose of these grounds by a common order.
4. We note that the assessee has suo motu made disallowance of
Rs.1,72,879/- on dividend income earned only of Rs.1,18,076/-.
5. Brief facts of the case are that the assessee company is engaged in
manufacturing and export of readymade fashion garments outside India to
countries like USA, Canada etc. During the year under consideration the
assessee company has done sales both export sales as well as domestic
sales. The assessee had electronically (e-return) filed return of income on
30.09.2008 at a total income of Rs.19,04,66,504/- after claiming deduction
under chapter VI-A of the Act. This return was processed u/s 143(1) of the on
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15.03.2010. The case was selected for scrutiny assessment and notices u/s
143(2) of the Act.
6. The AO noted that during the year under consideration, the assessee
company has shown dividend on mutual fund/ shares of Rs.1,18,076/- and
claimed the same as exempt u/s 10(33)/10(34) of the Act in the computation
of income but no disallowance u/s 14A of the Act on account of managerial
expenses etc incurred thereon to earn this exempt dividend income were
offered for taxation. Pursuant to the same, notice was issued by the AO on
this aspect. The assessee explained its stand before the AO, which was not
acceptable to him, so he invoked Rule 8D and computed the disallowance
to the tune of Rs.1,45,72,152/-.
7. Aggrieved by the order of the AO, the assessee preferred an appeal
before ld the ld CIT(A), who has given partial relief to the assessee. Aggrieved
by the said order of the ld CIT(A), the assessee and revenue are before us.
8. The ld counsel Shri Salil Agarwal submitted that during the year under
consideration, the assessee company earned dividend income of
Rs.1,18,076/- only on its investment in Shares/ Mutual funds which was claimed
as exempt income u/s 10(34)/10(35) of the Act. According to him, the
company has a wide capital base having share capital of Rs.19.29 crores
and reserves and surplus to the tune of Rs.201.15 crores, which shows that the
company is in possession of huge own funds on which no interest is being
paid and all the investment in shares and mutual funds amounting to Rs.41.68
crores as on 31.03.2008 was made out of its own funds. It was submitted by
the ld counsel that there was no fresh investment in shares/ mutual funds
being made during the year under consideration but the assessee company
has increased the borrowed capital (Loan Funds) by Rs.24.93 crores., total
amounting to Rs.435.85 crores as on 31.03.2008. Copies of the annual
accounts for the year ended 31.03.2008 giving the scheme of investments
discloses these facts. According to him, the borrowed capital was mainly
taken from banks for the purpose of working capital or capacity expansion of
the business and no borrowed funds were invested outside the business.
Considering the aforesaid facts the ld counsel submits that the investment
made by the company was out of its own funds (share capital and reserves)
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in previous year and no interest was incurred earning dividend income during
the year under consideration. According to him, the interest payment was
made for working capital requirement and no part of it can be attributed to
have been paid towards investment made in shares and securities. Further
reference was made to the decision of CIT vs. Hero Cycles, decided by
Hon'ble Punjab and Haryana High Court decided on November 4, 2009,
wherein the court has given decision as under (Head-note only):
"The assessee earned dividend income on shares which was exempt
from tax. The AO took the view that the investment in shares was' made
out of borrowed funds on which interest expenditure was incurred and
consequently made. a disallowance U/S 14A. This was partly upheld by
the CIT (A). On further appeal by the assessee, the Tribunal deleted the
disallowance by noting that the assessee had proved that the
investment in shares was made out of non-interest bearing funds. It
held that unless there was evidence to show that the interest - bearing
funds had been invested in the tax - free investments and the nexus
was established by the Revenue, s. 14A could not be applied on mere
presumption. The Revenue appealed to the High Court and claimed
that in view of s. 14A (2) and Rule 8D (1)(b), a disallowance could be
made even if the assessee claimed that no expenditure had been
incurred in 'respect of the tax - free income. HELD dismissing the
appeal:
(i) If the investment in the shares is out of the non-interest bearing funds,
disallowance U/S 14A is not sustainable;
(ii) The contention of the revenue that directly or indirectly some
expenditure is always incurred which must be disallowed U/S 14A
cannot be accepted;
(iii) Disallowance U/S 14A requires a finding of incurring of expenditure.
If it is found that for earning exempted income of expenditure has
been incurred, disallowance U/S 14A cannot stand;
9. Further, the ld AR submitted that the same issue of disallowance u/s14A
of the assessee company was examined in the A.Y. 2006-2007 & A.Y. 2007-
2008 and the CIT(A)-XVI, New Delhi; in Appeal No.183/2009-10 vide order
dt.17/05/2010 has accepted the contention of the assessee by allowing the
relief U/s 14A of the Act.
10. Reliance was placed on the following case laws by the ld counsel
where in it has been held that where assessee has interest free funds far in
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excess of amount invested in shares of other companies, no disallowance
could be made U/s 14 A on the ground that the interest bearing funds were
invested in earning tax free dividends:-
CIT Vs. HERO CYCLES LTD. (ITA No. 331 of 2009) (P & H)
MARUTIUDYOG LTD. Vs. DCIT (2005) 92 fTDIl9 (DEL)
ESCORTS LTD. Vs. ACIT (2006) 102 ITJ (DEL) 522
SHREE SYNTHETICS. LTD Vs. CIT & ANR_ (2006) 205 ITR 386 (MP)
11. According to the ld counsel the same view has been taken by ITAT 'B'
Bench (Delhi) in ITA No.2381/Del/2008 in the case of M/s Collections. In that
case the assessee was having capital of Rs.4,77,49,092/- and has made
investment of Rs.83,72,347/- on which tax free Income was earned. The AO
has observed that the said investments were made out of working capital of
the business and sum borrowed from the bank. At the end of the relevant
financial year the total amount payable to the bank was Rs.96,58,766/-. The
co-ordinate Bench observed that the AO has no where specifically stated
that interest bearing funds were used or investment purposes which has
generated interest free income. It was held by the Tribunal that since the
capital of the business is much more than the investment made, the interest
expenses incurred have been incurred for the purpose of business and the
same cannot be disallowed on peripheral reasons. On the basis of above
observation, the ITAT deleted the disallowance made by the AO u/s 14A of
the Act.
12. In the light of the aforesaid facts and circumstances and the
precedents relied upon the ld counsel prayed that the disallowance partly
confirmed by the ld CIT(A) also need to be deleted.
13. On the other hand, the ld DR relied on the order of the AO and
defended the action of the AO in applying Rule 8D which according to him
was in force during the relevant assessment year and the ld CIT(A) erred in
giving partial relief to the assessee, which according to him need to be set
right and so he pleaded that the order of the ld CIT(A) may be reversed and
AO's order be restored.
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14. We have heard both the parties and perused the records and have
gone through the case laws cited by both the parties. We find that the ld
CIT(A) has noted the facts of the case as given in the assessment order and
the submission of the AR of the appellant, it is seen that the assessee had
share capital of Rs.19.29 crores and reserves and surplus of Rs.201.15 crores,
sum of which far exceeded the investments of Rs.41.68 crores of the assessee
company in shares and mutual funds at the end of the year and therefore, as
held by various Hon'ble Courts, no interest expenditure can be held to be
attributable to earning to exempt income from share and mutual funds at the
end of the year and therefore, as held by various Hon'ble Courts, no interest
expenditure can be held to be attributable to earning of exempt income
from shares and mutual funds. Accordingly, no disallowance is warranted in
the appellant's case under Rule 8D(2)(i) and Rule 8D(2)(ii). We endorse the
finding of the ld CIT(A) to his finding that no disallowance is warranted in the
assessee's case under Rule 8D(2)(i) and Rule 8D(2)(iii) because considering
the facts, it is clear that the investment made by the assessee company in
the earlier years was out of share capital and reserves and surplus lying in the
balance sheet of the appellant company and on this amount no interest
expenses was incurred. We find that the assessee had sufficient funds to
make investment in the shares and securities on which interest fee income
was earned. And the interest payment was made for working capital
requirement and no part of it can be attributed to have been paid towards
investment made in share and securities.
15. However we find that the ld CIT(A) after rightly holding that Rule
8D(2)(i) and (ii) are not applicable to the case in hand, has resorted to apply
Rule 8D(2)(iii) on the ground that some administrative expenses is inevitably
incurred by the assessee for salary, management, telephone, stationary etc,
which in our opinion is not correct because the assessee himself has suo-
motto disallowed on amount of Rs.1,72,879/- for earning exempt income/
dividend to the tune of Rs.1,18,076/-. The AO can press into service the
alternate method of making disallowance u/s 14A by invoking Rule 8D only
where the AO is not satisfied with the working of disallowances given by the
assessee. We find that no such dissatisfaction has been recorded by the AO
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to state that the suo-motto disallowance made by the assessee is incorrect
and he has to resort to Rule 8D. The AO shall bear in mind that invoking Rule
8D is not mandatory, it will be resorted to only if he is not satisfied as to the
correctness of the claim made by the assessee as stipulated and mandated
in section 14A ; and invoking Rule 8D is not automatic ; and here the AO
erred in not recording his satisfaction as to why the suo motto disallowance
made by the assessee is incorrect, without doing so, his exercise to invoke
Rule 8D lacks jurisdiction.
16. Here the facts clearly indicates, as claimed by the assessee that no
borrowed funds were utilized for earning the exempt income by the assessee
and further the dividend were directly credited in the bank account of the
assessee and no expenditure was claimed. Whatever it may be, we find that
the assessee only received Rs.1,18,076/- as dividend income, therefore, there
is no question of disallowance of Rs.18,02,321/- by invoking section 14A r.w.
Rule 8D (2)(iii) under the facts available on record. It was also explained by
the ld. Counsel for the assessee that on identical facts in earlier years, no
disallowance was made by the assessee and it was accepted. In the present
assessment year also, no borrowed funds were invested by the assessee for
making investment in shares or for earning dividend income. Disallowance u/s
14A r.w. Rule 8D cannot in any rate exceed the expenditure that has been
actually incurred by the assessee as per its books of account for earning
exempt income and in the absence of exercise not carried out by the AO as
prescribed by section 14A before invoking Rule 8D as afore-stated, we find
force in the contention of the counsel of the assessee and direct that only
Rs.1,72,879/- suo- motto disallowed by the assessee can be upheld and the
rest of the addition made need to be deleted. The appeal of the assessee is
therefore allowed and appeal of the revenue on this ground is dismissed.
17. Next is the ground Nos. 3 and 4 of the appeal of the revenue which is
directed against the ld CIT(A)ordering deletion of the addition of
Rs.7,91,00,000/- made by the AO on account of product development
expenses as deferred revenue expenses.
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18. The ld DR submitted that the claim of the assessee that these designs
were given to the customers free of cost is one thing but it cannot be denied
that the sample and design created by the assessee and supplied to its
potential buyers create a market and goodwill for the assessee which has an
enduring benefit in soliciting customers for the assessee not only during the
Financial Year but also on a longer basis. According to the ld AR a perusal of
the financial statement of the assessee reveals that a major part of overseas
orders received by the assessee are on account of Its own efforts which
includes products design and development. In view of the above the entire
Product Development Expenses of Rs.11.87 Crores debited to Profit & Loss
Account and claimed as revenue expenses was disallowed by the AO and
said expenses were treated as deferred revenue expenditure in accordance
to the judgement of the Apex court In Madras Industrial Investment
Corporation Ltd Vs CIT 225 ITR 802. According to ld DR it was rightly held by
the AO that the benefit of the product development expenses of the
Company is derived by the company over a period of three years. So one
third of the product development expenses Rs. 3.95 crores is allowed in the
instant assessment year and the balance Rs.7.91 crores is disallowed for the
year to be allowable over the next two years as it is held by the AO that the
benefit in terms of creating market and goodwill for the assessee in the
international market is available for the assessee over a period of three years
for the expenditure made on the product development expenses. However
on appeal by the assessee before the ld CIT(A), he erred in deleting the same
holding the product development expenses as revenue expenses. Therefore
the ld DR wants us to reverse the order of the ld CIT(A) and restore the order
of the AO.
20. On the other hand the ld counsel submitted that during the year under
consideration, the assessee company incurred an expenditure of Rs.11.87 cr
on development of samples/ preparation of samples as per the requirements
of the foreign buyers. These expenses are of revenue nature and no benefit
of enduring nature is available to the assessee as the market of readymade
garments is seasonal and short lived; and style changes from season to
season. A detailed note on product development expenses was shown to us
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enclosed along with detail exceeding Rs.3,000/- to substantiate the claim of
the assessee company. It was submitted that the expenditures are in the
nature of sampling expenses and no new asset was created and also no
benefit of enduring nature is derived from such expenditures. Keeping in view
the short life and nature of styles and designs in readymade garments
business, it cannot be said that the assessee has acquired benefit of enduring
nature of developing samples of garments as per requirements of the buyers
as compared to other business areas. The ratio of the judgment in the case of
Madras Industrial Investment Corporation Ltd. 225 ITR 802 is not applicable as
the facts of the case are different from the facts of the assessee company. In
the said case, discount on debentures were written off over the period of
debentures as deferred nature. According to the ld counsel the assessee
company is regularly incurring sample development expenditures which are
of small amount and for a particular season/style and which may undergo
changes with the change in the season even within the same year and are
therefore, are of revenue nature. The ld counsel pointed out to us that earlier.
These expenses were never disallowed by the AO in the regular assessments
for assessment years prior to Assessment Year 2007-08. Similar addition was
made by the AO for the first time for Assessment Year 2007-8, and the
Learned CIT(A)-XVI, New Delhi, in Appeal No.1153/2009-10 vide order dated
17.05.2010 was pleased to delete the additions made on account of Product
Development Expenses.
21. The ld AR relied on the case law of CIT Vs. Haring Crank Shafts Ltd. 207
Taxation 737 (Del) where the jurisdictional High Court held that the product
development expenses were deductible as revenue expenditure. In the case
of Glaxo Smith Kline Consumer Healthcare Ltd. vs. ACIT 112 TTJ 94 (Chd), the
ITAT even held that the "expenses incurred for introducing and developing
new products of the same business were allowable as business expenses,
since no new line of business was acquired". Reference was also be made to
the case law of CIT vs. Bharat Earth Movers Ltd. (1986)155 ITR 321 (Kar)
wherein it was held that expenditure incurred on development of products is
a revenue expenditure. To the similar effect, Amritsar Bench of the ITAT, in the
case of DCIT vs. Max India Ltd. (2006) 105 TTJ 1002 (Asr) had also held that the
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expenses incurred by the assessee for improving and developing new
varieties of films were not capital in nature since these did not pertain to
extension of its business nor there was any change in the installed capacity.
Also , the expenses were not subject to section 35D of the Act as they were
allowable under section 37(1) of the Act, even if the assessee had amortized
these expenses in its books of account.
22. In the light of the aforesaid facts and case laws cited before us the ld
counsel does not want us to interfere with the order of the ld CIT(A).
23. We have heard both the parties and perused the records and case
laws cited by both the parties. We find that ld CIT(A) has followed the order
of his predecessor, who has held as follows:-
"There is no doubt that the assessee company is into the business of
manufacturing readymade garments and exporting them outside the
country. It is an established trade practice that before the start of the
season or even during the season itself, the manufacturers are
supposed to develop samples and send to the prospective buyers on
the basis of which the orders are placed. In view of the fact that the
Department has consistently allowed these expenses in the assessee
case in earlier years there seems to be no reason on which the AO can
disallow these expenses especially when the AO has not made out any
case that these expenses are either bogus in nature or capital in
nature."
24. And the ld CIT(A) concluded as under:-
"Also, the expenses were not subject to section 35D of the Act as they
were allowable under section 37(1) of the Act, even if the assessee had
amortized these expenses in its books of account. In conclusion, I hold
that having regard to the aforesaid discussion the claim of the
appellant for allowability of impugned expenditure as revenue
expenditure is justified. Accordingly, the assessing officer is directed to
delete the addition."
25. We find that such expenses were claimed by the assessee in earlier
years too and were being allowed by department. So by applying the rule of
consistency as laid by the Hon'ble Supreme Court in Radhasoami Satsang Vs.
CIT (1992) 193 ITR 321 (SC), we are of the opinion that there was no need to
take a different view, because, the facts permeating in earlier years have not
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changed. We concur with the opinion of the ld CIT(A) that expenses incurred
for developing samples as per the requirement of customers are allowable
expenses u/s 37(1) of the Act and are not covered by Section 35D of the Act.
We do not find any infirmity in the impugned order and we uphold the same
and dismiss the appeal of the revenue on this issue.
26. In the result the appeal of the assessee is allowed and revenue is
dismissed.
Order pronounced in the open court on 30.04.2015.
-Sd/- -Sd/-
(S.V.MEHROTRA) (A. T. VARKEY)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated:30/04/2015
A K Keot
Copy forwarded to
1. Applicant
2. Respondent
3. CIT
4. CIT (A)
5. DR:ITAT
ASSISTANT REGISTRAR
ITAT, New Delhi
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