Ita/471/2015 Of The Commissioner Of Income Tax v. M/S Microlabs Ltd

IN THE HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS THE 11 DAY OF MARCH, 2016 PRESENT THE HON BLE MR. JUSTICE JAYANT PATEL. AND| THE HON’BLE MRS. JUSTICE B.V.NAGARATHNA| INCOME TAX APPEAL NO.471/2015 BETWEEN: 1.THE COMMISSIONER OF INCOME-TAX,LTU, JSS TOWERS,LTU, JSS TOWERS, BSK III STAGE, BANGALORE - 560 O85. 2.|THE DEPUTY COMMISSIONER OF INCOME-TAX,LTU, JSS TOWERS, LTU, JSS TOWERS, BSK III STAGE, BANGALORE —- 560 085. ... APPELLANTS (BY SRI: K.V. ARAVIND, ADVOCATE) AND: M/S. MICROLABS LTD.,NO.2/7, K.C.N. TOWERS,RACE COURSE ROAD,BANGALORE.PAN: . ..,. RESPONDENT| OK OK THIS ITA IS FILED UNDER SEC.260-A OF INCOME TAX!ACT 1961, ARISING OUT OF ORDER DATED:05/03/2015)PASSED IN ITA NO.1412/BANG/2013, FOR THE ASSESSMENT|YEAR 2009-2010. THIS APPEAL COMING ON FOR ADMISSION THIS DAY,JAYANT PATEL J.,DELIVERED THE FOLLOWING:- JUDGMENT Tne appellant nas preferred the present appeal Dy raising two main substantial questions of law, which are as.under:| <(“Whether, on the facts and in_ thecircumstances of the case, the Tribunal IsrigntInlaw.Insettingaside|thecomputation made by tne assessingautnority InrespectOf|claim fordeduction under Section 35(2AB) of[.T.Act|eCVelwhentheassessingautnority rightlyadoptedthenet.expenaiture for allowing tne weighteddeduction and same was gone on theDasis of DSIR guidelines wherein it wasStated tnat the receipts to the in-nouseR&D centre needs to be reduced fromgross expenditure and in accordance withparameters of the provision? <<(WhetherOP)thefactsand|thecircumstances of the case, the Tribunalwas corrected in law in aeleting tneadaitionMadeunderSection1GA|computedUnderRule8D(2)(11)amounting to Rs.49,42,473/- even whenthe assessing authority rightly quantified the aforesaid disallowance under Section 14A as per Rule 8D? 2D.We nave heard Mr. Aravind, learned counsel|appearing for the appellant - Revenue. ‘3.On the first question, the observations madeby the Tribunal in the impugned order from paragraph|Nos.1272 to 1/7 are as unde "17. We have heard the submissions of the Id.DR and the ld. counsel for the assessee andalso perused the documents filed in paperbook.As we nave already seen, tne assessee carrieson scientific research. It is In the business of |manufacture of drugs and pharmaceuticals. Itincurred expenditure on scientific research anathe quantum of such expenditure on scientificresearcn, whicn is a sum Of Rs.7,80,52,805, Is not in dispute. Tne weighted deduction u/s.35(2AB) at 150% was claimed by tne assesseeat a sum of Rs.12,57,00,920. What is now to.be examined is the guidelines of DSIR, whicn-the prescribed authority u/s.35(2AB)(3) & (4)of the Act, nas to follow before grantingapproval of tne scientific researcn carried outby the assessee as eligible for deduction u/s.35.(2AB). A copy of the guidelines of DSIR its atpages 2/7 to 33 of assessee’s paperbook. Guidelines 5(vii) ts relevant for the presentcase and it reads as follows: “(VID |Assets acquired and products, ifany emanating out of R&D workqone in approved facility, snali notbe disposed off without approval ofthe Secretary, DSIR.Sales realization |arising out of the assets sold shall beoffset against the R&D expenditure of theR&DCentreclaimedundersection35(2AB) for the year in which such salesrealizationaCCrues|undersection 35(2AB) of IT Act, 1961. ExpenditureclaimedfordeductionUndertheSubsection shall be reduced to thetextent.” 13.The CIT(A) in nis order passed u/s. 154of the Act has not quoted the first sentence ofthe guideline 5(viil) (given above in bolaletters), which in our opinion, is very material.The above guideline only means that in theprocess of carrying out the R&D work, if theassessee acquires any assets or proaucts tnatshould not be disposed of without the approvalof Secretary, DSIR. If such assets are sold,the sales realization arising therefrom are to besetoff against the R&D expenditure of the R&Dcentre which is claimed as decuction U/SS. 13.The CIT(A) in nis order passed u/s. 154of the Act has not quoted the first sentence ofthe guideline 5(viil) (given above in bolaletters), which in our opinion, is very material.The above guideline only means that in theprocess of carrying out the R&D work, if theassessee acquires any assets or proaucts tnatshould not be disposed of without the approvalof Secretary, DSIR. If such assets are sold,the sales realization arising therefrom are to besetoff against the R&D expenditure of the R&Dcentre which is claimed as decuction U/SS. 35(2AB). It is evident from the aboveguideline tnat it is only sales realization arising:out of the|assets soldthat should be offsetagainst R&D expenditure. In respect of sale ofproducts acquired emanating out of R&D workdone in an approved facility, the sale proceedsneed|notbereduced.fromtheR&Dexpenditure. In our view, the reason for notincludingSalesrealizationArisingoutOf|products emanating out of R&D work done anaSold is Decause sucn sales would be reflectedas receipts by the assessee in its books ofaccount and [ncome from business would be|computed treating such sale as _ part obusiness receipts. The receipts arising out ofsale of products will not go to reduce theexpenaiture on R&D, whereas the assetsacquired in the process of carrying out the R&Dif they are sold, such sales realization would gotoreducetheexpenaitureOf)scientificresearch and that is wny sales realizationarising out of assets sold is required to beoffset against R&D expenditure. The aboveexplanation will be sufficient to noid that theorder passed by tne CIT(A) u/s. 154 of the Actis unsustainable. Nevertheless, we will also|examine as to whet is the exact neture ofreceipts from sale of products. 14.A copy of license and supply agreementwhich was filed by the assessee before the AO.as well as CIT(A) Is at pages 5 to 26 of theassessee’s paperbook. [ne sale of products isnotning but the sale of Dossiers by tneassessee to persons not associated witn theassessee or its directors. [In the course ofcarryingoutthescientificresearcn,theadSSCSSCEDrepalreselaboratedocumentsregarding tne products that would emanatefrom carrying out scientific researcn. Thiswould also include tne requirement of nea/tn—authorities for grant of license to approve theproducts for human use. The assessee givesthe Dossiers so prepared to entities outsideIndia, who are interested in getting themarketing authorization for the product in aparticular territory. They pay to tne assesseethe Dossier cnarges and apply for license tomarket the products for human use in theirrespective territories. On getting the license,they get marketing authorization from theassessee. [ne person who takes tne Dossier(Knownow) takes it for the limited purpose ofregistration of product in other countries anaafter registration sale of the products in tneircountry. If they get any order M/s. Micro Labswill manufacture and sell them at agreed price.So the knowhow given to them its only for limited purpose of registering with the drugcontro! authorities for approval for humanconsumption. The foreign entities wno get thedossiersWITTgetrightstO markettheassessee’s products in tneir territory and theactual manufacture in course of time will be|qone by M/s. Micro Labs Limited t.e., theAssessee. 15.All intellectual property rights, title andinterest of any kind whatsoever in and/or tothe Dossier and tne Products shall be ftheexclusiveproperty|Of|MICROLABS(tne|Assessee). MICRO LABS i.e., the Assesseemay sell tne Dossier to any third party,including its clients without the consent offoreign entity buying the dossier. However,MICRO LABS (the Assessee) shall notify theperson acquiring the dossier of the transfer orsale of the Dossier to such third party and snailundertake tnat sucn third party respect theterms and conditions of the agreement withthe other third party who buys dossier fromthe Assessee., 15.All intellectual property rights, title andinterest of any kind whatsoever in and/or tothe Dossier and tne Products shall be ftheexclusiveproperty|Of|MICROLABS(tne|Assessee). MICRO LABS i.e., the Assesseemay sell tne Dossier to any third party,including its clients without the consent offoreign entity buying the dossier. However,MICRO LABS (the Assessee) shall notify theperson acquiring the dossier of the transfer orsale of the Dossier to such third party and snailundertake tnat sucn third party respect theterms and conditions of the agreement withthe other third party who buys dossier fromthe Assessee., 16.DSIR guidelines no. vil has specificallyprovided that assets acquired if any out of R &D work snali be disposed witn approval ofDSIR. Tne assessee nas been submittingyearly audit reports & accounts of approved R & D sanction to DSIR. The R & D accounts|Nave been separately maintained and separateP & L Account prepared and tne dossier saleshave been credited to P & L Account of R & Dbecause these sales are part of normal sales. L/.It is clear from tne sample copy of tnelicense and supply agreement filed before usthat tne product development charges receivedby the assessee will not be covered underClause 5(vii) of the DSIR guidelines. As wenave alreaay seen, these receipts are creditedto profit & loss account are part of normalsales. They are, therefore, not to be reduceqfrom tne expenditure incurred by the assesseeon carrying out scientific research on whichdeduction u/s. 35(2AB) nas to be allowed. Weare, therefore, of the view that there is nomerit in ground No.2 raised by the revenueana that tne order passed by tne CIT(A)DATED 9.4.2014 U/S. 154 of the Act cannot besustainead and the same is nereby reversed.Thus, ITA No.764/B/14 by the assessee isallowed, wnile ground No.2 raiseaq by therevenue Is dism|/ssed.” The aforesaid paragraphs show that the Tribunal hasproceeded on the premise tnat when the regular work is in|the nature of R&D work done and sold, it becomes a. business income and chargeable as business income. It is)only when the assets acquired in the process of carrying|on R&D work, if they are sold, such realization would go toreduce tne expenditure of scientific researcn. 4In our view, the approach to the issueconsidered by tne Tribunal is appropriate. In any case, no)substantial question of law would arise for consideration ascanvassed. 5.For the second question, the observationsmade by the Tribunal in the impugned order reads as)under: “32. Ground No.2 raised by the assesseereads as follows:- “D2The learned Commissioner of [Income Tax(Appeals) has erred in sustaining the additionsmade by the assessing officer u/s. 14A readwith rule 8D on the ground that the appellant:Nas not proaquced the evidentiary support inrelation to dispersal of loan and utilization ofloan. Whereas the appellant nas produced theevidence that the amount [Invested was out ofpositive bank balance and no borrowings wereutilized for the purpose of investment. ” 33.The assessee earned dividend income ofRS.38,/75,85/7[t|quantifiedaSUTTOf|Rs.3,22,426 as expenditure incurred in earning:tax free [ncome dividend [ncome which does|not form part of the total income and which ts-to be disallowed u/s. 14A of the Act. 34.The break-up of the sum of Rs.3,22,426is not specifically given, but is stated to berelatingTo managementfee,legalaprofessionalCnarges, securitytransactioncharges and NSDL charges. It is thus clearthat the assessee by implication had claimeathat there was no expenditure incurred by wayof interest, either directly or indirectly, which ts_attributable to the Dorrowed funds whicn were|used for the purpose of investment whichyielded tax free income. 33.The assessee earned dividend income ofRS.38,/75,85/7[t|quantifiedaSUTTOf|Rs.3,22,426 as expenditure incurred in earning:tax free [ncome dividend [ncome which does|not form part of the total income and which ts-to be disallowed u/s. 14A of the Act. 34.The break-up of the sum of Rs.3,22,426is not specifically given, but is stated to berelatingTo managementfee,legalaprofessionalCnarges, securitytransactioncharges and NSDL charges. It is thus clearthat the assessee by implication had claimeathat there was no expenditure incurred by wayof interest, either directly or indirectly, which ts_attributable to the Dorrowed funds whicn were|used for the purpose of investment whichyielded tax free income. 35.The AO observed that Schedu/e G to theFinancial Statements of the assessee had|Shown)Investment To theTuneOf|Rs.28,45,29,937 in shares mutual funds ofvarious companies. He was of the view tnatsuch investments cannot be maae routinely.No prudent businessman would make anyinvestment witnout applying the’ resourceswisely. Obviously this entails expenditure,direct as well as Indirect. He thereafter| proceeded to make disallowance u/s. 14A ofthe Act, wnicn is given as annexure to tneassessmen_.order|andCNCIOSECaS|*ANNEXUREII to this order. 36.Aggrievead by the assessment order, theadSSCSSCEpreferredappealbeforetheCIT(Appeals). 3/,.Before CIT(A), the assessee submittedthat interest bearing loans were borrowed forspecific purposes and not for investmentDUFPpOSesand.Insupportof.theabove|contention, theASSCSSECEfiledcopiesOf|balance sheetsaS|Of)31.03.7003upto—31.03.7009 to show thet the various loans|availed from banks were all taken for specificpurposes and could not have been utilized formaking any investments out of which exemptIncome was earned. [nese loans [include snort|term loans from IDBI Bank, Exim Bank,Barclays Bank and Standard Chartered Bank inrespect of which it was explained that theloans could not have been used for making anylong term investment. Copies of some|communications from banks regarding sanctionof the loans were also filed before me ftosubstantiate the nature of the loan. In respect’of IDBI loan, it was submitted that the same| had been returned back before the year end,thus bringing the balance to Nil. 38.On|considerationof.theabove|submissions and on perusal of the relevantqocuments, tne CIT(A) was of the view tnatthe claim of the Assessee was not evidencedfrom the documents submitted in view of the|loans and other sources of funds being mixedup in the common pool of funds. The CIT(A)further held that the burden of proof in thismatter clearly continues to rest witn theAssessee and that it was not enough to merelyshow that surplus funds were available or thatbank loans had been availed for specificpurposes inciuding short term reasons. A one-|to-one correlation must also be established to prove that the loans were absolutely utilizeqfor the purpose for which they were claimed.The CIT(A) alsoheldthatthere.Washhoutilization certificate from the bank filed beforethe AO nor was such evidence furnished beforethe CIT(A). Tne CIT(A) also held that thedocuments submitted from the bank during thecourse of appeal only refer to the disbursal ofthe loan and even these specify certainconditions required to be met. The date-wiseactual disbursal and utilization is not provedfrom the ledger copies as submitted. TheCIT(A) also referred to the decision of Mumbai ITAT in the case of Hercules Hoists Ltd. (ITANo. 7944, 7946, 2255 & 7943/mum/2011),wherein it was held that with the introductionof Rule 8D the burden of proof on the assesseeNas become “more stringent, so that ratherthan snowing existence of sufficient capital, thematter would be required to be examined fromthe stand point of utilization of the borrowedinterest bearing funds.” In the absence ofcategorical utilization certificate from the bank,the CIT(A) was of the view that there was noevidentiary support of tne assessee’s claim.Hence, the disallowance u/s.14A of the Act asmade by tne AO was upheld by the CIT(A). ITAT in the case of Hercules Hoists Ltd. (ITANo. 7944, 7946, 2255 & 7943/mum/2011),wherein it was held that with the introductionof Rule 8D the burden of proof on the assesseeNas become “more stringent, so that ratherthan snowing existence of sufficient capital, thematter would be required to be examined fromthe stand point of utilization of the borrowedinterest bearing funds.” In the absence ofcategorical utilization certificate from the bank,the CIT(A) was of the view that there was noevidentiary support of tne assessee’s claim.Hence, the disallowance u/s.14A of the Act asmade by tne AO was upheld by the CIT(A). 39.Aggrieved by the order of CIT(A), theassessee Nas raised ground No.2. 40.We nave heard the rival submissions. ACOPYof.theavailabilityof.fundsand.investments made was filed before us which Is at pages 38 to 42 of the assessee’s paperbDook*and the same is enclosed asANNEXURE''' to this order7 It is clear from the Said.statement that the availability of profit, sharecapital and reserves & surplus was mucn morethan investments made by tne assessee whicncould yield tax free income. 4].The Hon’ble Bombay High Court inRellance Utilities & Power Ltd. 313 ITR 340|(Bom) nas neld that wnere tne interest freefunds far exceed the value of investments, it Ssnould be considered that investments heavbeen made out of interest free funds and no!aisallowance U/sS. 14A towards any interestexpenaiture can be made. Tnis view was againconfirmed by the Hon’ble Bombay High Courtin CIT v. HDFC Bank Ltd., ITA No.330 of 2012,judgment dated 23.77.14, wherein it was nellthat when Investments are meade out ofCOmMmmMpoolOf|fundsand|non-interest.bearing funds were more than the investmentsin tax free securities, no disallowance ofinterest expenditure U/s. 14A can be made. 4.In the light of above said decisions, weare of the view that disallowance of interest|expenses in the present case of RS.49,42,473.made under Rule 8D(2)(li) of the I.T. Rulessnould be deleted. We order accordingly.” Tne aforesaid snows tnat the Tribunal nas followed adecision of the Bombay High Court in the case ofCITv. |HDFC Bank Ltd., (ITA No.3s30/2012 disposed of on3025231467. When the issue is already covered by a)decision of the High Court of Bombay with which we concur, we do not find any substantial question of law. would arise for consideration as canvassed. 6. In view of the above observations, the appeal Is dismissed. Sd/-— JUDGE Sd/-' JUDGE. S*|