Following Earlier Rulings, ITAT Mumbai Allows DSIR-Unapproved R&D Expenditure As Business Deduction

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has allowed Manugraph India Limited to claim ₹22 lakh in research and development (R&D) expenditure as a business deduction. The amount had not been approved by the Department of Scientific and Industrial Research (DSIR) for weighted deduction.

The tribunal followed earlier decisions that permitted such claims under the Income Tax Act.

A bench of Judicial Member Pawan Singh and Accountant Member Makarand Vasant Mahadeokar noted that coordinate benches of the Delhi and Bengaluru ITAT had previously taken the view that R&D expenditure which does not qualify for weighted deduction under Section 35(2AB) may still be allowed under Section 37(1).

Applying the same view to Manugraph's case, the Bench directed the assessing officer to grant the deduction.

"We find that co-ordinate bench of Delhi Tribunal in Auto Ignition Ltd. vs ADIT (supra) while considering the similar ground of appeal held that R&D expenditure though not eligible weighted deduction under section 35(2AB) but is allowable under section 37(1) to the extent of amount expenditure incurred by assessee," the tribunal observed.

Manugraph India Limited, which manufactures and exports precision and sophisticated printing machines, had claimed weighted deduction on expenditure incurred on its in-house research and development activities for assessment years 2016-17 and 2017-18.

For assessment year 2016-17, the company debited about ₹1.90 crore as revenue expenditure on R&D in its profit and loss account. It claimed a weighted deduction on that amount in its computation of income. The company also claimed weighted deduction on capital expenditures of about ₹1 lakh.

The DSIR subsequently approved R&D expenditure of about ₹1.68 crore. Based on that approval, the assessing officer restricted the weighted deduction claim to the approved amount and denied the balance weighted deduction claimed by the assessee.

The company challenged the disallowance. It argued that the expenditure had been incurred for the purposes of its business and should therefore be allowed under Section 37(1) or Section 35(1)(i).

The Revenue opposed the claim. It contended that weighted deduction had already been allowed to the extent approved by the DSIR and that the assessee could not claim the same expenditure under a different provision.

The Tribunal noted that the Commissioner of Income Tax (Appeals) had rejected the assessee's alternative claim.

"The alternative plea of assessee that uncertified portion may be allowed under section 37(1) / 35(1)(i) was also rejected by ld. CIT(A) as it was not approved so deduction automatically cannot be considered as general expenditure under section 37(1) without demonstrating that it meets criteria of research and development expenditure," the tribunal recorded.

The bench then examined decisions of the Delhi ITAT in Auto Ignition Ltd. and the Bengaluru ITAT in BEML Ltd. Those benches had held that expenditure not eligible for weighted deduction under Section 35(2AB) could nevertheless be allowed under Section 37(1).

Following those decisions, the Tribunal granted relief to the assessee.

The bench also considered the company's challenge to the disallowance relating to exempt income. The assessing officer had computed the disallowance by taking into account all investments.

Accepting the taxpayer's contention in part, the tribunal directed the assessing officer to consider only those investments that had actually yielded exempt income while recomputing the disallowance. It also directed deletion of the interest disallowance after noting that the company's interest-free funds were far in excess of its investments.

Another dispute concerned rent of ₹13.2 lakh paid for a farmhouse at Alibaug. The property had been taken on leave and licence from persons related to the company. The assessee claimed that the farmhouse was used to accommodate foreign customers and business visitors.

During the hearing, the company furnished details of two foreign visitors who had stayed at the property. One was a managing director from Russia who visited for negotiations relating to a web offset printing machine. The other was the head of procurement of a Japanese company. Both stayed for only one night.

The tribunal noted that rent had been claimed for six months. It further noted that the material placed before it showed only two foreign clients staying at the property for one or two days during that period.

The bench observed that while expenditure incurred wholly and exclusively for business purposes is allowable, the taxpayer must establish the business purpose of the expenditure. It found that the material on record did not justify allowance of the entire claim.

"Thus, in order to avoid the possibility of revenue leakage, the disallowance is restricted to 50% of the rental expenses. The disallowance is also restricted to that extent keeping in view that the firm house is in the name of directors of the assessee company and personal use is not ruled out," the tribunal held.

The appeals for assessment years 2016-17 and 2017-18 were partly allowed.

For Appellant: Senior Advocate K. Shivram with Rahul Hakani,

For Respondent: Annavaram Kosuri- Sr. DR