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Personnel costs, administrative & other manufacturing expenses incurred during pre-operative period, for expansion of business, is allowed as revenue expenditure: ITAT

2019-TIOL-1544-ITAT-CHD

IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH ‘B’ CHANDIGARH

ITA No.1156/Chd/2013
Assessment Year: 2008-09

M/s SML ISUZU LTD
(FORMERLY KNOWN AS M/s SWARAJ MAZDA LTD)
SCO: 204-205, SECTOR 34-A, CHANDIGARH

Vs

ADDITIONAL COMMISSIONER OF INCOME TAX
RANGE IV, CHANDIGARH

ITA No.1193/Chd/2013
Assessment Year: 2008-09

ADDITIONAL COMMISSIONER OF INCOME TAX
CIRCLE-4(1), CHANDIGARH

Vs

M/s SML ISUZU LTD
(FORMERLY KNOWN AS M/s SWARAJ MAZDA LTD)
SCO: 204-205, SECTOR 34-A, CHANDIGARH

Sanjay Garg, JM & Dr B R R Kumar, AM

Date of Hearing: May 29, 2019
Date of Decision: July 2, 2019

Appellant Rep by: Shri Ajay Vohra, Sr. Adv.
Respondent Rep by: 
Shri G S Phani Kishore, CIT DR

Income Tax – Preoperative expenditure – Expansion of business – Setting up a new division.

THE assessee company, engaged in the business of designing, development, manufacture, assembling, marketing and distribution of commercial vehicles, filed return for relevant AY. In relevant year, the assessee, had expanded its existing portfolio of commercial vehicles and had set up a new division within its existing premises for manufacturing additional models of commercial vehicles, luxury bus bodies with new design and technology. The assessee incurred the expenditure, a total Capital work-in-progress of Rs. 8090.59 lacs and amount recovered from sale of Rs. 81.57 lacs. The assessee capitalized all expenditure net of sale realization under the head “capital work-in-progress”. The assessee in its return of income declared these expenditure as capital in nature. However, later on, the assessee filed a revised return claiming additional deduction out of the capital work-in-progress declared in earlier return treating certain expenditure as revenue expenditure, incurred on account of personnel costs, administrative expenses and other manufacturing expenses incurred during the pre-commercial operation period. In the assessment order the AO disallowed the expenditure on the ground that there was expansion of the business which had not commenced commercial operations during the year and hence, expenditure incurred could not be allowed as revenue expenditure. On appeal, the CIT(A) confirmed the action the AO.

On appeal, Tribunal held that,

Whether on expansion of the business, during pre-operative period, personnel costs, administrative expenses and other manufacturing expenses incurred by the assessee on the project will be allowable as revenue expenditure – YES : ITAT

++ in some of the case laws cited by the Counsel for the assessee, the facts were different. However, the decision of the Delhi High Court in the case of ‘Jay Engineering Works Ltd.’ is found applicable wherein it has held that where a new unit set up is only an expansion of the business of the assessee, the pre-operative revenue expenditure incurred by the assessee on the project will be allowable expenditure. The facts of the case are squarely covered by the decision of the Delhi High Court. The DR could not bring any contrary decision to the proposition of law laid down by the Delhi High Court. Even there is no denial of the fact that the expenditure claimed by the assessee is otherwise revenue in nature and not relating to the set up of the plant. In view of this, this ground of appeal is hereby allowed and disallowance made by the AO on this issue is ordered to be deleted.

Assessee’s appeal partly allowed

ORDER

Per: Sanjay Garg:

1. The present are cross appeals, one by the assessee and the other by the Revenue against the order of the Commissioner of Income Tax (Appeals), Chandigarh [hereinafter referred to as ‘CIT(A)’], dated 22.10.2013 relating to assessment year 2008-09, passed u/s 250(6) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’).

2. Since both the appeals arose out of the same order of the CIT(A) involving identical facts and circumstances and the same have been heard together and are being disposed off by this common order for the sake of convenience. First we take up the appeal of the assessee in ITA No.1156/Chd/2013.

ITA No .1156/Chd/2013 (Assessee’s Appeal):

3. The assessee in this appeal has taken the following grounds:

“1. That the Ld. CIT (A) is not justified in confirming the assessment made by the Ld. A. 0. u/s 143 (3) by holding that assessment is not barred by limitation, whereas the assessment made by the Ld. A. O. u/s. 143 (3) is barred by limitation and be quashed.

2.a) That the Ld. CIT (A) is not justified in confirming the addition of Rs.10,12,24,416/- by holding that the said expenditure was treated as pre-operative expenditure by the appellant. How can the appellant claim expenditure as revenue expenditure, once it has itself named and has claimed it as pre-operative expenditure.

b) That without prejudice to above, the appellant disputes the quantum of addition.

3.a) That the Ld. CIT (A) is not justified in confirming the disallowance of interest amounting to Rs.1,80,52,000/- on adhoc basis.

b) That without prejudice to above, the appellant disputes the quantum of disallowance.

4. That the appellant craves leave for any addition, deletion or amendment in the grounds of appeal on or before the disposal of the same.”

Ground No.1:

4. At the outset, the Ld.Counsel for the asssessee has submitted that as per the instructions of his client, he does not want to press ground No.1. Hence, ground No.1 raised by the assessee is dismissed as not pressed.

Ground No.2 :

5. Vide ground No.2, the assessee has agitated the confirmation of addition made by the A.O. in respect of preoperative expenditure incurred by the assessee for expansion of its business by way of setting up a new division for additional models of commercial vehicles.

6. The brief facts relevant to the issue are that the assessee has been engaged in the business of designing, development, manufacture, assembling, marketing and distribution of commercial vehicles. In the previous year relevant to the assessment year under consideration, the assessee, to expand its existing portfolio of commercial vehicles, had set up a new division within its existing premises for manufacturing additional models of commercial vehicles i.e. luxury bus bodies with new design and technology. The assessee for the above new division incurred the following expenditure during the year:

A total Capital work-in-progress = Rs.8090.59 lacs

Net of amount recovered from sale = Rs. 81.57 lacs of vehicles

7. The assessee capitalized all the aforesaid expenditure net of sale realization under the head “capital work-inprogress”. The assessee accordingly filed its original return of income on 28.9.2008 declaring the aforesaid expenditure as capital in nature. However, later on, the assessee filed a revised return on 26.3.2009 claiming additional deduction out of the capital work-in-progress declared in ear lier return treating certain expenditure as revenue expenditure (amounting to Rs.10,12,24,416/-) incurred on account of personnel costs, administrative expenses and other manufacturing expenses incurred during the precommercial operation period. In the assessment order the A.O. disallowed the aforesaid expenditure on the ground that there was expansion of the business which had not commenced commercial operations during the year and hence, expenditure incurred could not be allowed as revenue expenditure. The A.O. further observed that the assessee had itself capitalized the aforesaid expenses as part of CWIP in the original returns and, therefore, admitted that the said expenditure was capital in nature. The A.O. thus held that the expenses towards expansion of the business were not allowable as revenue deduction.

8. On appeal, the CIT(A) vide order dated 22.10.2013 confirmed the action the A.O. in treating the expenses incurred as capital in nature.

9. Before us, the Ld.Counsel for the asssessee has submitted that the impugned expenditure was incurred by the assessee though, during the pre-commercial operation period, however, the same was incurred for the expansion of already existing business of the assessee and further that the said expenditure was purely revenue in nature and not relating to setting up of the plant. The Ld.Counsel for the asssessee in this respect has relied upon the following decisions to stress the point that the revenue expenditure incurred for setting up of a new unit, which is a part of existing business of the assessee, is allowable as a business deduction:

1) Setabganj Sugar Mills Ltd. Vs. CIT, 41 ITR 272 2002-TIOL-1206-SC-IT-LB

2) Produce Exchange Corporation Ltd. Vs. CIT, 77 ITR 739 2002-TIOL-2442-SC-IT-LB

3) Veecumsees Vs. CIT, 220 ITR 185 (SC)

4) DCIT Vs. Core Health Care Ltd., 298 ITR 194 (SC) = 2008-TIOL-17-SC-IT

5) DCIT Vs. Gujarat Alkalies & Chemicalls Pvt. Ltd., 299 ITR 85 (SC) 2008-TIOL-21-SC-IT

6) CIT Vs. Monnet Industries Ltd, 221 CTR 266 (Del.HC) 2008-TIOL-586-HC-DEL-IT affirmed by SC-350 ITR 304

7) CIT Vs. Escorts Auto Components, 323 ITR 11 (P&H) 2010-TIOL-325-HC-P&H-IT

8) CIT Vs. Modi Industries Ltd. (No.3), 200 ITR 341 (Del.)

9) CIT Vs. Relaxo Footwears Ltd., 293 ITR 231 (Del.) = 2007-TIOL-221-HC-DEL-IT

10) CIT Vs. Usha Iron & Ferro Metal Corp Ltd., 296 ITR 140 (Del) 2007-TIOL-287-HC-DEL-IT

11) CIT vs. Priya Village Road Shows Ltd.: 332 ITR 594 (Del) 2009-TIOL-747-HC-DEL-IT

12) Indo Rama Synthetics Ltd.: 333 ITR 18 (Del)

13) CIT vs. Havells India Ltd. : 352 ITR 376 (Del) = 2012-TIOL-1144-HC-DEL-IT

14) CIT v. Triveni Engineering and Industries Limited.: 181 Taxman 5 (Del.) 2009-TIOL-46-HC-DEL-IT

15) CIT vs. Rane (Madras) Ltd.: 293 ITR 459 (Mad.) = 2007-TIOL-551-HC-MAD-IT

16) Prem Spinning & Weaving Mills Co. Ltd. vs. CIT: 98 ITR 20 (All.)

17) Kashiram Ramgopal vs. CIT : (1988) 36 Taxman 305 (MP)

18) Addl. CIT vs. Aniline Die Stuffs & Pharmaceuticals Pvt. Ltd.: 130 ITR 843 (Bom.)

19) CIT vs. Alembic Glass Industries Ltd.: 103 ITR 716(Guj.) = 2003-TIOL-186-HC-AHM-IT

20) Rainbow Dyestuff Ltd. v. CIT: 213 ITR 560 (Guj.)

21) Kesoram Industries & Cotton Mills vs. CIT : 196 ITR 846 (Cal.)

22) CCIT vs. Senapathy Whitely Ltd.: 101 CTR 31 (Kar.)

23) Jay Engineering Works Ltd. vs. CIT: 311 ITR 405 (Del. HC) = 2007-TIOL-558-HC-DEL-IT

24) CIT v. Ghanashyam Steel Work Ltd.: Lex ID 390033 (Guj.) = 2010-TIOL-441-HC-AHM-IT

25) CIT v. Sakthi Sugars Ltd.: 339 ITR 400 (Mad.) 2010-TIOL-572-HC-MAD-IT

26) Glaxo Smithklme Consumer Healthcare Ltd V. ACIT: 112 TTJ 94 (Chd)

27) Raymond Limited v. JCIT: ITA No.6243/Bom/ 1995 (Mum)

28) DCIT vs. Magnetic Meter Systems India Ltd.: 13 ITR (T) 43 (Chen.)

29) ACIT vs. Jupiter Corporate Services Ltd.: 6 ITR (Trib.) 264 (Ahmd.)

10. The Ld.Counsel for the asssessee has further submitted that the new unit was set up in the same premises which was expansion of the already commenced business of the assessee set up to manufacture the additional models of commercial vehicles to enhance the existing portfolio of the assessee and to increase its existing production capacity. There was a common control and management in respect of the already existing units as well as the new unit set up in the same premises. That the expansion of the facilities was funded partly through bank loans and partly through internal accruals of the existing units. Even the existing dealer network is being used to sell the new models of vehicles.

11. The Ld. DR, on the other hand, has submitted that the aforesaid expenditure has rightly been disallowed by the A.O. as the same relates to pre-operative period of the new unit and the same cannot be allowed as revenue expenditure.

12. We have considered the rival contentions. We find that in some of the case laws cited by the Ld.Counsel for the asssessee, the facts were different. However, the decision of the Hon’ble Delhi High Court in the case of ‘Jay Engineering Works Ltd.’ (supra) is found applicable wherein it has held that where a new unit set up is only an expansion of the business of the assessee, the pre-operative revenue expenditure incurred by the assessee on the said project will be allowable expenditure. The facts of the case are squarely covered by the aforesaid decision of the Hon’ble Delhi High Court. The Ld. DR could not bring any contrary decision to the above proposition of law laid down by the Hon’ble Delhi High Court. Even there is no denial of the fact that the expenditure claimed by the assessee is otherwise revenue in nature and not relating to the set up of the plant. In view of this, this ground of appeal is hereby allowed and disallowance made by the A.O. on this issue is ordered to be deleted.

Ground No.3:

13. Vide ground No.3 the assessee has agitated the confirmation of disallowance of interest amounting to Rs.180.52 lacs on adhoc basis.

14. The brief facts relevant to the issue are that during the year under consideration, the assessee availed long term loan of Rs.60 crores from Allahabad Bank primarily for financing its expansion activities and incurred interest expenditure aggregating to Rs.3.73 crores, out of which interest amounting to Rs.3.55 crores was capitalized by the assessee based on actual utilization of funds. The remaining amount out of the interest expenditure was claimed as revenue expenditure. The A.O., however, took the figures of opening capital work-in-progress and closing capital work-in-progress and calculated the interest expenditure @ 10% on the average investment on capital work-in-progress and calculated the same at Rs.535.97 lacs. After reducing the interest already capitalized of Rs.355.45 lacs, the A.O. made the addition of Rs.180.52 lacs into the income of the assessee under the proviso to section 36(1)(iii) of the Act.

15. The Ld.CIT(A) confirmed the disallowance so made by the A.O.

16. Before us, the Ld.Counsel for the asssessee has submitted that during the year the assessee had availed loan of Rs.60 crores. Out of the aforesaid loan, a sum of Rs.51.06 crores was utilized for the purpose of capital expansion and further a sum of Rs.4.07 crores was utilized for repayment of short term loans which were also taken for the purpose of capital expenditure. Hence, the assessee utilized total amount of Rs.55.13 crores out of the loan funds and capitalized the proportionate interest expenditure of Rs.355.45 lacs out of the total interest expenditure incurred of Rs.373.75 lacs. He, therefore, has submitted that the A.O. without appreciating the above factual position has made a disallowance on adhoc basis, which even exceeds the total amount of interest expenditure incurred by the assessee of Rs.3.73 crores.

17. The Ld. DR could not rebut the aforesaid factual aspects.

18. In view of the above discussion, since the assessee already capitalized the interest expenditure as per actual utilization, there was no justification for adhoc disallowance made by the A.O., which even exceeds the actual interest expenditure incurred by the assessee. In view of this, the disallowance on this issue is restricted to the extent of suo moto capitalized by the assessee and the addition made by the A.O. is ordered to be deleted.

Ground No.4:

19. Ground No.4 is general in nature and does not require any adjudication.

20. In view of our above observations, the appeal of the assessee is treated as partly allowed.

21. Now coming to the appeal of the Revenue in ITA No.1193/Chd/2013.

ITA No.1193/Chd/2013 (Revenue’s Appeal):

22. The Revenue in this appeal has taken the following grounds:

“1. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in allowing appeal of the assessee without appreciating the facts of the case.

2. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in deleting the addition of Rs.1,87,66,884/- made by the A.O. under section 145A by including excise duty in closing stock of work in progress.

3. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in deleting the addition of Rs.37,00,000/- made” by the AO on account of excess claim of warranty than actual utilization which is merely a provision and liability of contingent nature.

4. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in deleting the addition of Rs. 1,10,21,222/ -made by the AO on account of bad debts written off especially when the receivable were on account of dues from Government/Semi Government organizations.

5. The appellant craves leave to add or amend any grounds of appeal before the appeal is heard or is disposed off.”

Ground No.1:

23. Ground No.1 is general in nature and hence, does not require any adjudication.

Ground No.2:

24. Vide ground No.2, the Revenue has agitated the action of the CIT(A) in deleting the addition made by the A.O. u/s 145 of the Act by including excise duty in closing stock of work-in-progress.

25. At the outset, the Ld.Counsel for the asssessee has submitted that the issue raised in this appeal is squarely covered by the common order of the Tribunal dated 14.5.2018 in the own case of the assessee passed in ITA No.1234/Chd/2011 & Others relating to assessment years 2005-06 to 2007-08.

26. We have gone through the aforesaid order of the Tribunal (supra) and found that the Tribunal under identical facts vide para 30 of the order dated 14.5.2018 (supra), passed in ITA No.79/Chd/2009 made the following observations:

“30. We have considered the rival contentions. In the case in hand, the assessee has not paid any excise duty on the closing work in progress and hence there was no question of loading any excise duty on estimation basis. Even otherwise, if the value of excise duty has to be included in the closing stock then the value of excise duty has also to be included in the opening stock and in that event there would be no difference in the result of the value of the opening stock and closing stock. Reliance in this respect is placed on the decision of Delhi High Court in the case of ‘Purolator India Ltd. ‘ (supra) and of Allahabad High Court in the case of ‘CIT vs. Sangam Structural Ltd.’ (2013) 35 taxmann.com 148 (All).”

27. In view of this, the issue is squarely covered by the decision of the Tribunal for the earlier assessment years. No contrary decision has been brought before us by the Department. We, therefore, do not find any merit in this ground and the same is dismissed.

Ground No.3:

28. Vide ground No.3, the assessee has agitated the decision of the CIT(A) in deleting the addition of Rs.37 lacs made by the A.O. on account of provision for warranty.

29. The brief facts relevant to the issue are that during the year under consideration, the assessee debited to the Profit & Loss Account the provision on account of warranty claim amounting to Rs.303 lacs. On being asked to explain the assessee explained that the assessee was engaged in the business of manufacturing and distribution of commercial vehicles. That the assessee was under the obligation to replace/rectify the defective parts or other manufacturing defects occurring during the specified period of usage of products by the customers. That the war ranty period varied according to the nature of product and market practices. The assessee further explained that the provision for the year under consideration was calculated on the basis of average actual warranty cost of previous three years. The A.O., however, did not agree with the above contention of the assessee and disallowed the provision for warranty expenses to the extent of Rs.37 lacs holding that the same was excess provision of warranty made with a view to lessen the profits of the year. The A.O. noted that the average provision for warranty for 5 years from 2004-05 to 2007-08 amounted to Rs.270.50 lacs and average actual claims during the said period amounted to Rs.223.25 lacs, resulting in excess claim of amount of Rs.47.25 lacs. The A.O. further noticed that for the relevant year, the provision made exceeded the actual claim by Rs.37 lacs and hence, proceeded to make disallowance of the said amount.

30. On appeal against the aforesaid order, the Ld.CIT(A) deleted the disallowance of Rs.37 lacs made by the A.O. by holding that the assessee had worked out the provision of warranty on the basis of a scientific method, which had consistently been followed for the last several years.

31. We have considered the rival contentions. There is no dispute that the provision of warranty was an allowable deduction. The A.O., however, has held that the provision of warranty as claimed by the assessee was excessive. The Ld.Counsel for the asssessee in this aspect has invited our attention to a chart to show that the assessee has calculated the provision for warranty on a very scientific basis, by considering the average actual warranty cost of previous three years per vehicle sold. We have gone through the aforesaid chart. The assessee in this chart has mentioned the warranty provision created for financial years 2005-06, 2006-07 and 2007-08. The warranty provision was created by taking the average warranty per vehicle. The assessee created the warranty provision of Rs.291 lacs for financial year 2005-06, of Rs.272 lacs for financial year 2006-07 and of Rs.303 lacs for financial year 2007-08(the relevant assessment year under consideration). Against the aforesaid provision, the total warranty claim received relevant to financial year 2005-06 in subsequent year was Rs.368 lacs. Similarly, for financial year 2006-07, the total warranty claim received in subsequent years was Rs.357 lacs and for the assessment year under consideration i.e. for financial year 2007-08, the total warranty claim received was Rs.383 lacs, which was more that the provision created. The CIT(A) has given a categorical finding that the method adopted by the assessee was a scientific method. Moreover, the provision for warranty created by the assessee has been accepted by the Department till assessment year 2007-08. Hence, based on the principle of consistency as well as considering that the provision was calculated by adopting a consistent method, we do not find any infirmity in the order of the CIT(A) in deleting the disallowance made by the A.O. on this issue. This ground of appeal is accordingly, dismissed.

Ground No.4:

32. Vide ground No.4, the Revenue has agitated the action of the CIT(A) in deleting the addition of Rs.1.10 crores made by the A.O. on account of bad debts written off.

33. The A.O. noted that the assessee had written off a sum of Rs.165.66 lacs as bad debts out of the provision for bad and doubtful debt account. Out of the aforesaid amount, an amount of Rs.1.10 crores pertained to the amount recoverable from Government Agencies. The A.O. held that the amount recoverable from the Government could not be held to be bad debt as it would amount to labeling the Government as bankrupt. He, therefore, disallowed the deduction of bad debts written off to the tune of Rs.1.10 croroes. However, the Ld.CIT(A) deleted the addition so made by the A.O. observing that since the assessee had written off the claim of bad debts as irrecoverable in the books of account, hence the disallowance was not warranted.

34. We have heard the rival contentions and have gone through the orders of the authorities below. The main reason for the disallowance of the aforesaid bad debts by the A.O. was on the ground that the bad debts in question were relating to the amount recoverable from the Government, which the assessee could not recover and that it could not be said that the Government had become bankrupt.

35. The Ld.Counsel for the asssessee has submitted that the supplies were made by the assessee to the Government Departments during past years. About 95% to 98% of the payment was received against the delivery of vehicles/spare parts. However, the balance 2% to 5% of the payment was to be released by the Government after final inspection and issuing of satisfactory inspection report by the appropriate authority of the concerned Departments to the concerned accounting wings of Central Government. The Ld.Counsel for the asssessee has further submitted that in respect of certain cases, the balance payment ranging from 2% to 5%, as noted above, which was to be released subject to certain formalities, got stuck because of various reasons including non-receipt of inspection report by the competent authority. The assessee could not recover outstanding amounts despite best efforts. The Ld.Counsel for the asssessee has further submitted that sometimes the value of the efforts, time and expenditure required to be incurred for the clearance/purformance of the formalities is more than the actual amount due and considering the fact that there was no likelihood of recovery, outstanding amount aggregating to Rs.1.10 crores was written off by the assessee during the assessment year under consideration.

36. The Ld. DR, on the other hand, has submitted that the A.O. rightly disallowed the aforesaid bad debts and write off of bad debts pertaining to outstanding amount against the Government.

37. We have considered the rival contentions. We find force in the contention of the Ld.Counsel for the asssessee that some times due to certain difficulties/impediments, it is not possible to complete the requisite formalities and even sometimes it is beyond the control of the assessee to get the necessary approval and further that sometimes the value of the required time and efforts applied for the recovery of dues is more than the actual amount recoverable and hence, in the overall business interests, it is deemed prudent to write off such debts. The assessee in this case has written off bad debts as there was no likelihood of recovery of the aforesaid outstanding amount. In view of this, we do not find any justification on the part of the A.O. to make the impugned disallowance merely because the recovery was outstanding against the Government. This ground of appeal of the Revenue is, therefore, dismissed.

Ground No.5:

38. Ground No.5 raised by the Revenue is general in nature and does not require any adjudication.

In view of our discussion made above, there is no merit in the appeal of the Revenue and the same is accordingly, dismissed.

39. In the result, the appeal of the assessee in ITA No.1156/Chd/2013 is partly allowed and the appeal of the Revenue in ITA No.1193/Chd/2013 is dismissed.

(Order pronounced in the Open Court on 2.7.2019)

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