COMMISSIONER OF INCOME-TAX VS SUNDARAM FASTENERS LTD., 1998 PTD-MADRAS-HIGH-COURT-INDIA 3355 (1996)

Income-tax--

----Expenditure on scientific research---Deduction---Machinery used in business transferred by assessee to scientific research cell ---Assessee entitled to deduction of written down value of machinery as expenditure on scientific research---"Incurred", meaning of---Indian Income Tax Act, 1961, S.35.

The assessee did business in manufacture of fasteners used for automobiles. During the accounting year ending with March 31, 1975, relevant to the assessment year 1975-76, the assessee transferred certain plant and machinery to the scientific research cell. The machinery had hitherto been used for regular production. The written down value, at the time of transfer, was stated to be Rs. 1,71,821. This amount, was claimed by the assessee as capital expenditure under section 35(1)(iv) read with section 35(2) of the Income Tax Act, 1961, as expenditure incurred on scientific research related to the business carried on by the assessee. The Income-tax Officer rejected the assessee's claim on the ground that the expenditure on these assets had been incurred in earlier years when the assets were first brought into use in the business and it could not again be treated as capital expenditure for the purpose of section 35(1)(iv) in the relevant assessment year. The Tribunal allowed the assessee's claim. On a reference:

Held, that the expenditure to be deducted under section 35(1)(i) of the Act should be incurred on scientific research carried on by the assessee or on his behalf. The expression "incurred" in section 35(2)(i) of the Act has to be understood in the' context of the method of accounting followed by the assessee. The assessee followed the mercantile system of accounting. Admittedly, the machinery and equipment transferred to the scientific research and development section was in fact required for that department for scientific research relating to the business of the assessee. The assessee could incur expenditure, purchase the machinery and provide the same for scientific research in the accounting year relevant to the assessment year under consideration. The assessee could also transfer its machinery for the purpose of scientific research and development. There was no prohibition in section 35(1)(iv) of the Act on transferring a part of the assets of the assessee-company towards scientific development and expenditure. Setting apart machinery for scientific research and development is also transfer of assets for scientific research and development. Therefore, the assessee was entitled to the deduction of its own capital expenditure for the assessment year under consideration under section 35(1)(iv) of the Act.

Belpahar Refractories Ltd. v. CIT (1994) 207 ITR 144 (Orissa); CIT v. Nainital Bank Ltd. (1966) 62 ITR 638 (SC); Escorts Ltd. v. Union of India (1993) 199 ITR 43 (SC) and Indian Molasses Co. (P.) Ltd. v. CIT (1959) 37 ITR 66 (SC) ref.

C.V. Rajan for the Commissioner. P.P.S. Janarthana Raja for the Assessee.

JUDGMENT

THANIKKACHALAM, J.---At the instance of the Department, the Tribunal referred the following question for the opinion of this Court under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "the Act"):

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee is entitled to deduction under section 35(1)(iv) on the written down value of the assets of Rs.1,71,281 transferred by the assessee to the research and development section?"

The assessee-company is doing business in manufacture of fasteners used for automobiles. During the accounting year ending with March 31, 1975, relevant to the assessment year 1975-76, the assessee transferred certain plant an4 machinery to the scientific research cell. Those machinery were hitherto used for regular production. The written down value, at the time of transfer, was stated to be Rs.1,71,821. This amount was claimed by the assessee as capital expenditure under section 35(I)(iv) read with section 35(2) of the Act, as expenditure incurred on scientific research related to the business carried on by the assessee. The Income-tax Officer rejected the assessee's claim on the ground that the expenditure on these assets had been incurred even in the earlier accounting years, when they were first brought into use in the business and it cannot be again treated as a capital expenditure for the purpose of section 35(1)(iv) of the Act simply because, the assessee chose to transfer them to the research and development section in a later year. Aggrieved the assessee filed an appeal before the Commissioner (Appeals). The Commissioner (Appeals), following the earlier order of the Bangalore Bench of the Tribunal, dated February 21, 1974, in I. T. A. No. 178/(Bang) of 1972-73 in the case of Bharat Electronics Ltd., for the assessment year 1971-72, allowed the assessee's appeal. Aggrieved, the Revenue filed a second appeal before the Tribunal. The Tribunal upheld the order of the Commissioner of Income-tax (Appeals).

Before us, learned standing counsel for the Department submitted that the Tribunal was not correct in granting deduction of expenditure by the assessee to the extent of Rs.1,71,821 since that expenditure was not incurred in the assessment year under consideration. According to learned standing counsel, the said amount is not an expenditure going out of the hands of the assessee in the assessment year under consideration. It was pointed out that the machinery was purchased earlier and when the machinery was purchased in the earlier years, the expenditure would have been incurred for purchasing the machinery. After using the machinery in its business, if the assessee transfers the machinery for the purpose of, scientific research and development, it cannot be said that the assessee would have incurred expenditure in the assessment year under consideration for claiming benefit under section 35(1)(iv) of the Act. Inasmuch as the expenditure has not gone out of the hands of the assessee, the assessee cannot claim deduction under section 35(I)(iv) of the Act. According to learned standing counsel for the Department, unless the assessee irretrievably loses the expenditure incurred, the assessee is not entitled to say that the assessee incurred the expenditure in the assessment year under consideration. Therefore, according to learned standing counsel, the expenditure was not incurred in the assessment year under consideration, the expenditure said, to have been incurred has not gone out of the hands of the assessee and it was not irretrievably lost. Therefore, the assessee is not entitled to claim deduction under section 35(1)(iv) of the Act. In order to elucidate the meaning of the words, "spending" and "expenditure", learned standing counsel appearing for the Department relied upon the two decisions reported in Indian Molasses Co. (P.) Ltd. v. CIT (1959) 37 ITR 66 (SC) and CIT v. Nainital Bank Ltd. (1966) 62 ITR 638 (SC). Reliance was also placed upon a decision of the Supreme Court in Escorts Ltd. v. Union of India (1993) 199 ITR 43 in order to contend that the assessee is not entitled to claim deduction under section 35(1)(iv) of the Act. Finally, learned standing counsel also relied upon a decision of the Orissa High Court in Belpahar Refractories Ltd. v. CIT (1994) 207 ITR 144 in order .to contend that the assessee is not entitled to deduction under section 35(1)(iv) of the Act.

On the other hand, learned counsel appearing for the assessee submitted that the assessee-company established a research and development department. The assessee transferred certain machinery for research and development. The assessee incurred capital expenditure in the assessment year under consideration, while transferring certain machinery for scientific research and development. Even though the machinery was purchased earlier and used in the business of the assessee, the used machinery was transferred for scientific and research development. Therefore, the assessee claimed deduction under section 35(1)(iv) of the Act on the written down value of the machinery transferred. According to learned counsel for the assessee, the assessee can set apart its assets for the purpose of scientific research and development by way of either providing money for purchasing the new machinery or transferring its assets which were used in its business and it is also open to the assessee to get back the machinery provided for scientific research and development so as to use the same for its own business. Learned counsel for the assessee further pointed out that there is prohibition under the amended provision to claim both depreciation and deduction of capital expenditure under section 35(1)(iv) of the Act. Learned counsel for the assessee further submitted that the decision of the Bangalore Bench of the Tribunal, dated February 21, 1974. rendered in Bharat Electronics Ltd.'s case was accepted by the Department and no reference application was filed. It was, therefore, submitted that the order passed by the Tribunal in granting deduction of capital expenditure under section 35(1)(iv) of the Act is in order.

We have heard both learned standing counsel for the Department as well as learned counsel for the assessee. In the accounting year relevant to the assessment year, the assessee established a department for scientific research and development. The assessee transferred some of its machinery for scientific research and development. The written down value of the said machinery comes to Rs.1,71,821. On this amount, the assessee claimed deduction under section 35(1)(iv) read with section 35(2) of the Act. This was rejected by the Department on the ground that the expenditure on these assets had been incurred even in the earlier accounting years, when they were first brought into use for the purpose and it cannot again be treated as a capital expenditure for the purpose of section 35(l)(iv) of the Act, merely because the assessee chose the transfer them to the research and development in the later years.

"Scientific research" is defined by section 43(4) of the Act. The expenditure to be deducted under section 35(1)(i) of the Act should be incurred on scientific research carried on by the assessee or on his behalf. Under section 35(1)(iv) of the Act read with section 35(1)(ia) of the Act, any expenditure incurred by a taxpayer on scientific research related to the business carried on by him is allowed in full in computing the taxable profits of the business of the year in which such expenditure is incurred. The expression "incurred" in section 35(2)(i) of the Act has got to be understood in the context of the method of accounting followed by the assessee. The assessee in the present case is following the mercantile system of accounting. It is not disputed in the present case that the machinery and equipment transferred to the scientific research and development were in fact required for that department for scientific research relating to the business of the assessee. In fact, the assessee can incur expenditure, purchase the machinery and provide the same for scientific research in the accounting year relevant to the assessment year under consideration. The assessee can also transfer its machinery for the purpose of scientific research and development. -The assessee can provide either in cash or in kind for scientific research and development for the advancement of its own business. There is no prohibition in section 35(1)(iv) of the Act for transferring a part of the assets of the assessee-company towards 'scientific development and expenditure. According to learned standing counsel for the Department, inasmuch as the expenditure was incurred in the earlier years for purchasing the machinery, which were transferred in the assessment year under consideration, deduction cannot be claimed under section 35(1)(iv) of the Act since the expenditure was not incurred in the present assessment year under consideration. It remains to be seen that in the present assessment year under consideration, the assessee transferred certain machinery, which were used by the -assessee for its own business. Therefore, the assessee parted with certain machinery for the purpose of scientific research and development. While considering the meaning of the word "spending", the Supreme Court in Indian Molasses Co. (P.) Ltd. v. CIT (1959) 37 ITR 66 held that "spending" in the sense of "paying out or away" of money is the primary meaning of "expenditure". "Expenditure" is what is paid out or away and is something, which is gone irretrievably. Expenditure, which is deductible for income-tax purposes is one which is towards a liability actually existing at the time, but the putting aside of money which may become expenditure on the happening of an event is not expenditure. This meaning given by the Supreme Court attributable to the word "spending" is only for the purpose of explaining the word spending. According to section 35(1)(iv) of the Act, deduction is possible even in the case of capital expenditure. Capital expenditure is different from revenue expenditure. Therefore, this meaning given by the Supreme Court in the abovesaid decision would not render any assistance to the Department to show that unless the assessee expended money, the assessee is not entitled to claim deduction under section 35(1)(iv) of the Act.

Reliance was also placed upon a decision of the Supreme Court in CIT v. Nainital Bank Ltd. (1966) 62 1TR 638, wherein the Supreme Court while explaining the meaning of the expression "expenditure" held that in its normal meaning, the expression "expenditure" denotes "spending" or "paying out or away", i.e. something that goes out of the coffers" of the assessee. A mere liability to satisfy an obligation by an assessee is undoubtedly not "expenditure": it is only when he satisfies the obligation by delivery of cash or property or by the settlement of accounts that there is expenditure. But Expenditure does not necessarily involve actual delivery of or parting with money or property. If there are cross-claims---one by the assessee against a stranger and the other by the stranger against the assessee- and as a result of the accounting the balance due only is paid, the amount which is debited against the assessee to the settlement of the accounts may appropriately be termed "expenditure" within the meaning of section 10(2)(xv) of the Act. Therefore, it remains to be seen that the meaning given to the expression "expenditure" is only in relation to section 10(2)(xv) of the Act. But in section 35(1)(iv) of the Act, the assessee is entitled to claim deduction for capital expenditure. Therefore, this decision also would render no assistance to the Department to contend that the assessee is not entitled to deduction under section 35(1)(iv) of the Act. Reliance was also placed upon the decision of the Supreme Court in Escorts Ltd. v. Union of India (1993) 199 ITR 43. This decision relates to the amendment effected by the Finance (No.2) Act, 1980, by introducing section 35(2)(iv), which came into effect from April 1, 1962. According to the said decision, the assessee is not entitled to claim both the deduction under section 35(1)(iv) of the Act as well as the depreciation under section 32 of the Act. Lastly, reliance also was placed upon a decision of the Orissa High Court in Belpahar Refractories Ltd. v. CIT (1994) 207 ITR 144, wherein the Orissa High Court, while considering the provisions of section 35(2)(ia) of the Act geld that the word "incur" means "to become liable to", e.g., to incur debt, loss, etc. When an expenditure is said to have been incurred, it may connote actual payment or it could be that the person concerned has merely become liable for payment but has not actually made the payment. When a person has made advance payment but has not become liable for the payment, he cannot be said to have incurred any expenditure.

According to the facts arising in this case, the Income-tax Officer found that an amount of Rs.4,59,691 was the opening balance carried forward as work-in-progress from the earlier year,` and held that capital expenditure incurred in any previous year was to be allowed as deduction for that previous year only and as such the amount having been incurred in the year was not allowable as deduction in the year in question. The order of the income-tax Officer on this aspect was accepted by the Commissioner (Appeals) and the Tribunal. On a reference the Orissa High Court also agreed with the view taken by the 'Tribunal. According to the decision of the Supreme Court cited supra, the expenditure incurred for the earlier years cannot be claimed in the present assessment year under consideration. There is no difficulty in understanding the judgment rendered by the Orissa High Court on this aspect. According to the facts arising in the present case, the machineries were transferred by the assessee in the accounting year relevant to the assessment year under consideration for scientific research and development. For the purpose of scientific research and development, the assessee can set apart or incur any expenditure either by way of cash or by way of providing machinery. Setting apart machinery for scientific research and development is also transfer of assets for scientific research and development. Even according to the decision of the Supreme Court in CIT v. Nainital Bank Ltd. (1966) 62 ITR 638, since the machinery were acquired earlier and used in the business of the assessee, the assessee could claim deduction under section 35(1)(iv) of the Act on the written down value of the machinery. It is also open to the assessee to get back the machinery provided for scientific research and development for the purpose of its own business. The only prohibition is that the assessee should not claim deduction based on the accounting procedure, under section 35(1)(iv) of the Act and the depreciation under section 32 of the Act. According to the facts arising in the present case, as the assessee satisfied all the conditions prescribed under section 35(1)(iv) of the Act read with section 35(2) of the Act the assessee is entitled to the deduction of its own capital expenditure for the assessment year under consideration under section 35(1)(tv) of the Act.

Accordingly, we answer the question referred to us in the affirmative and against the Department. No costs.

M.B.A./1621/FCReference answered.