Whether an assessee can claim depreciation on machinaries installed at dealer's site for purpose of providing after sales service - YES: ITAT

THE questions before the Bench are - Whether an assessee can claim depreciation on the machinaries installed at the dealer's site for the purpose of providing after sales service; Whether security amount collected from customers can be excluded from the cost of assets for the purpose of calculating depreciation; Whether advances given for the purposes of acquisition of capital assets can be claimed as ‘bad debt’, when these are written off; Whether losses in the running of business can be said to be of capital nature and Whether when any income is exempt u/s. 10, the same has to be mandatorily excluded from the purview of computation of total income under different sections. And the verdict partly goes in favour of the assessee.

Facts of the case

A) Assessee concern had installed certain machineries at the premises of its dealers, who owned the “branded show rooms” under the name and style “Apollo Tyre World”/”Apollo Radial World”. The cost of machineries installed was Rs.88,22,753/-. The assessee had also collected security deposits from those dealers @ 50% of the cost of machineries and claimed the said sum as revenue expenditure, though it had capitalised the same in its books of account. During assessment, AO held that the amount spent on purchase of machineries was capital in nature and accordingly disallowed the said claim. AO further held that the depreciation on these machineries was not allowable, since they were used in the premises of the dealers and not by the assessee. It was further opined that the depreciation, if found to be allowable, the same had to be allowed only on 50% of the cost of machineries, as the other 50% has been collected by the assessee as security deposit from the concerned dealers. On appeal, CIT(A) had agreed with the view of the AO that the amount spent on purchase of machineries, though installed in the premises of the dealers, was capital in nature. However, the CIT(A) held that the depreciation was allowable on the entire amount of Rs.88,22,753/- on the basis that the purpose of installation of machineries at the show rooms of the dealers was to provide better after sales service which will affect the sales turnover of the assessee. Thus the machineries were used by the assessee as a part of sale promotion program and hence these machineries were used for the purposes of business of the assessee. The assessee had collected security deposit @ 50% of the cost of machineries and the same will remain as a liability, so long as the assets were not transferred back to the assessee. Hence, the amount of security deposit cannot be reduced from the cost of asset.

B) Assessee gave a sum of Rs.2.76 crores as advance towards purchase of machinery. Since the deal did not materialise and since the supplier adjusted the said advance against his charges towards cost and time spent for refurbishing and modifying the machinery, the assessee wrote off the advance in its books of account and claimed the same as deduction. During assessment, AO disallowed the said claim by holding that assessee had not disclosed the above said amount as its income in any of the year and hence the same was not allowable u/s 36(1)(vii). On appeal, CIT(A) held that the said claim was not allowable even as business loss or business expenditure, since it was a capital loss. It was observed by the CIT(A) that the appellant’s claim of deduction u/s 36(1)(vii) was not at all allowable in view of sec. 36(2) as the amount written off had not been taken for computation of income during the previous year or earlier years. Admittedly the advance was for purchase of capital asset like plant and machinery. The advance given to foreign collaborator was shown as work in progress (WIP) in asset account. Therefore, when the same amount was lost or written off, it would be a case of loss of capital which cannot be allowed as deduction.

C) Assessee claimed that the provisions of sec.70 do not prohibit set off of long term capital loss incurred on sale of equity shares and mutual fund units against the long term capital gain earned on sale of land. However, during assessment, it was negated by the AO and observed that for AY 2005-06 capital gain on sale of share was exempt u/s. 10(38). Hence neither the gain nor the loss on the sale of shares (for which STT has been paid) can be considered for Income Tax purposes. Regarding this, assessee replied that in accordance with the provisions of sec. 70(3), the assessee was entitled to had any loss arising on account of transfer of any long term capital asset set off against income, if any, arising on account of transfer of any other capital asset in the same assessment year.

AO observed that there was no merit in the argument of the assessee. So far as shares were concerned, Sec. 70(3) had not applicable to the assessee’s case with effect from AY 2005-06, sec. 10(38) stipulates that if security transaction tax was to be charged, income from transfer of such shares were exempt from the provision of taxation. As correctly pointed out by the assessee sec. 70(3) comes into play only when a computation of taxable income under the head “Capital gains” was made u/s. 48 to 55. Thus whatever income was exempt under the different Clauses of sec. 10, they had to be removed from the purview of income before computing the total income of any person. Thus once an income (which includes loss also) was exempt, computation had not to be done. Sec 70(3) becomes applicable only after computation of income as per the provisions of sec. 48 to 55 was made. In the present case there was no computation as the whole transaction had to be ignored. Needless to say sec. 70(3) was subject to sec. 10. Thus when an amendment was made in sec. 10 exempting result of certain transactions, no corresponding amendment to sec. 70(3) was called for as these two sections were mutually exclusive. And as regards the argument that to claim exemption u/s. 10(38), assessee had to prove that they had complied with the condition therein, it had to be noted that exemption u/s. 10 was granted not when a claim was made. It was granted if the condition stipulated therein was satisfied. The necessity of proving the condition comes up only when the AO found that conditions were not satisfied. On appeal, CIT(A) also confirmed the stand taken by the AO.

D) Assessee had not claimed this expenditure in its ROI and hence there was no occasion for the AO to examine this claim. M/s Apollo Tyres Ltd had manufactured certain type of tyres in the plant belonging to M/s Premier Tyres Ltd, which it had taken on lease. The said products were supplied to the export market through M/s Apollo International Trading LLC, Dubai. Since there were certain manufacturing defects, the above said M/s Apollo International Trading LLC, dubai lodged quality claims with M/s Apollo Tyres Ltd. Since the products were manufactured from the factory belonging to M/s Premier Tyres Ltd, M/s Apollo Tyres Ltd passed on this quality claim to the said company. During assessment of M/s Premier Tyres Ltd, the AO disallowed the said claim on the reasoning that the products had been manufactured by M/s Apollo Tyres Ltd, with which M/s Premier Tyres Ltd was not concerned with. The said disallowance was also confirmed by the CIT(A) on appeal preferred by M/s Premier Tyres Ltd. Before Tribunal, AR had submitted that the amount of quality claim was disallowed in the hands of M/s Premier Tyres Ltd and hence it may be allowed in the hands of the assessee herein. However, AR could not furnish the details relating to the “Quality claims”. AR submitted that the assessee had only passed journal entries in its books of account on the basis of certain correspondences and fairly admitted that he could not produce the details at this stage.

Having heard the matter, Tribunal held that,

A) ++ the assessee has not challenged the decision of CIT(A) in holding that the cost of machineries installed in the “Apollo Radial World”, i.e., at the dealers’ premises, is capital in nature. The only dispute is about the depreciation allowable on the cost of those machineries. According to the assessing officer, these machineries cannot be said to be used for the purposes of business of the assessee and hence no depreciation is allowable on them. In this connection, we are inclined to accept the view taken by the CIT(A). As rightly pointed out by the first appellate authority, the object of providing these machineries is to provide better after sales service, which would in turn help to increase the turnover of the assessee. These machineries are used to provide after sales service to its customers, which otherwise the assessee is expected to do. Thus, it is seen that the assessee has adopted a business strategy. Hence, we agree with the view of the CIT(A) that these machineries are used for the purpose of business of the assessee only;

++ with regard to the amount of security deposit collected from the customers, we notice from the agreement that it remains the liability of the assessee till the agreement is cancelled. So long as the agreement remains in force, the security deposit will remain as the liability of the assessee. Further, it is clearly provided in the agreement that the dealer shall hold the machineries in trust. The question of refund/adjustment of deposit arises only on the event of the dealer choosing to give up/discontinue the Car Radial Business. Hence, in our considered view, it cannot be said that the dealers have contributed money for purchase of these machineries. Hence the question of adjustment of security deposit against the cost of assets for the purpose of computation of depreciation does not arise. Accordingly, we uphold the view taken by CIT(A) on these two issues;

B) ++ this bench of the tribunal also considered an identical issue in the assessee’s own case in ITA No.430/Coch/2009 relating to the assessment year 2007-08. The Tribunal, vide its order dated 24-08-2012 decided the said issue and observed that the advances given for the purposes of acquisition of capital assets or for towards revenue purposes cannot be claimed as ‘bad debt’ u/s 36(1)(vii). Accordingly, in our view, the AO was not correct in drawing support from the said section. With regard to the advance given for acquisition of revenue items, the assessee gets support from the decision of Delhi HC in the case of Mohan Meakin Ltd Vs. CIT (2011-TIOL-286-HC-DEL-IT); wherein the HC, held that the trade advances written off can be allowed as deduction u/s 37;

++ in the case of Mysore Sugar Co. Ltd, the Apex Court had observed that to find whether an expenditure is on the capital account or on revenue, one must consider the expenditure in relation to the business. Since all payments reduce capital in the ultimate analysis, one is apt to consider a loss as amounting to a loss of capital. But this is not true of all losses, because losses in the running of business cannot be said to be of capital. The questions to consider in this connection are : for that was the money laid out ? Was it to acquire an asset of an enduring nature for the benefit of the business, or was it an outgoing in the doing of the business? If money be lost in the first circumstance, it is a loss of capital, but if lost in the second circumstance, it is a revenue loss. In the first, it bears the character of an investment, but in the second, to use a commonly understood phrase, it bears the character of current expenses. By following the test laid down by the SC, we hold that the advances given for acquisition of Capital assets is liable to disallowed as ‘Capital loss’ and the advances given for acquisition of revenue items is allowable u/s 37 as current expenses. Since the view expressed by CIT(A) on this issue is in tune with the view taken by the Tribunal, we do not find any infirmity in his order on this issue;

C) ++ we find merit in the view expressed by the AO on this issue. The CIT(A) had summarised the scheme of the Act and observed that the Assessing Officer has rejected this argument stating that when any income is exempt u/s. 10, the same has to be excluded from the purview of computation of total income under different sec. including those of sec. 48 to 55. Thus, once income which includes loss is exempt, the same cannot be taken for computation. She has also rejected the assessee’s contention that for claiming exemption u/s 10(38), the assessee has to claim it and prove that the conditions stipulated therein are satisfied. She has rightly pointed out that exemption u/s. 10 is granted not as per claim of the assessee but as per fulfilment of conditions stipulated therein. On going through the order of the AO, I find that she has rightly rejected the claim of the assessee. Sec. 70 provides for set off of loss from one source against income from another source under the same head of income. The very scheme of such set off implies that the source in respect of which a loss has occurred, is such that, had there been profit instead of loss they would have been chargeable to tax. In the assessee’s case, Long Term Capital Gain on sale of land is taxable whereas Long Term Capital gain on sale of share on which SIT has been paid, is exempt. In view of the above, we uphold the order passed by CIT(A) on this issue;

D) ++ in the instant case, there is no dispute that the debit note for “Quality claim” has been received from a group concern. The assessee herein has not accepted the said claim and hence it has passed on the claim to the lessor (M/s PTL Enterprises Ltd) from whom, the assessee had taken the plant on lease. In the normal course, the lessor has also accepted the liability and accordingly accounted the same in its books of account. Thus, the assessee herein did not bear the liability, but has acted as a pipe line in collecting the liability from the lessor and passing on the same to the group concern, M/s Apollo International Trading LLC, Dubai. However, in the income tax proceeding carried in the hands of M/s PTL Enterprises Ltd, the AO therein had not allowed the claim, since the lease agreement did not provided for such an eventuality and further no proof was produced in respect of the said claim. There cannot be any dispute that expenditure claim is allowable under the Act subject to the provisions contained therein, if it was incurred for the purposes of the business. In the instant case, the assessee herein has not accepted the liability relating to the “Quality claim”. It has passed on the liability to the lessor and the lessor has also accepted the said liability. It is pertinent to note that the lessor M/s PTL Enterprises Ltd is also a group company. The assessee is putting forth claim for deduction of expenditure relating to “Quality Claim” only for the reason that the said claim was disallowed in the hands of M/s PTL Enterprises Ltd, even though the said company had accepted the liability for the same. We have already noticed that the disallowance was made in the hands of M/s PTL Enterprises Ltd for the reason that the said assessee failed to furnish any proof. The View expressed by the Kerala HC in respect of transactions between group concerns has been extracted above. Under these circumstances, in our view, the assessee herein is not entitled to claim deduction relating to “Quality claims”. Accordingly, we reject the ground raised by the assessee on this issue. In the result, the appeal of the revenue and the appeal of the assessee are treated as partly allowed for statistical purposes.