Kalpesh Classes

Royalty payment for use of patents – is not scientific research

In the SUPREME COURT OF INDIA, Ciba of India Ltd. Expenditure laid out or expended on scientific research related to the business of a person is an admissible allowance in computation of the taxable profits and gains of the business of the assessee. One of the conditions of the admissibility of an allowance is that the expenditure must be laid out or expended on scientific research by the assessee. The amounts paid by the assessee were not laid out or expended by the assessee on scientific research related to the business of the assessee.​​ Payment made to recoup another person for expenditure for scientific research incurred by that other person, even if it may ultimately benefit the assessee is, unless it is carried on for or on behalf of the assessee, not expenditure laid out or expended on scientific research related to the business of the assessee.

Expense on on going construction - Allowed

In HIGH COURT OF MADRAS, Rane Brake Linings Ltd.As per section 35(1)(iv ), in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee, such deduction as may be admissible under the provisions of sub-section (2) shall be allowed. Section 35(2)(ia) provides that in a case where such capital expenditure is incurred,​​ the whole of such capital expenditure incurred in any previous year shall be deducted for that previous year. The section refers only to ‘capital expenditure’ and does not further require that the asset brought into existence by incurring such expenditure should have been complete in all respects. The deduction is for the expenditure to the extent incurred.​​ Expenditure incurred on on-going construction of a building designed for housing the research wing is clearly capital expenditure and is deductible under this provision.

Transfer of business assets to research department – 35 not allowed

In the HIGH COURT OF RAJASTHAN, JAIPUR BENCH, Multi Metals Ltd. The assessee-company claimed deduction of expenditure on scientific research under section 35. The value of assets included a sum which represented the written down value of the assets, which were acquired in an earlier assessment year. These assets were used for the purpose of business but transferred to the scientific research side in the relevant assessment year. That entry had been reversed subsequently. The Assessing Officer negatived the assessee’s claim.​​ 

Nothing had been brought on record that after transfer of the assets from business side to the research side, what research the assessee had made with the help of machinery. The use of the machinery was the same as that in the earlier year. In the earlier year, the machinery was used for production or manufacture of goods. If same use had been taken of the machinery in the relevant year, how the assessee could get the benefit of section 35.​​ It cannot be the intention of the Legislature that mere entry in the books of account from one head to other head will change the character of the assets for the purpose of allowance.

By the scheme of the Act, it is clarified in the Explanation to section 43(1) that the assets which are acquired for the purpose of scientific research and after some time they are transferred to the business side and the assessee wants to make use of those assets for business, the depreciation on those assets shall be allowed in the light of Explanation 1 to section 43(1), but there is no provision for allowing the benefit of section 35 on the assets​​ which were initially used in the business for production of the articles and things. In the absence of such a provision, the mere entry in the books of account from one head to other head, would not make the assessee eligible for deduction under section 35.​​ 

In the HIGH COURT OF MADRAS, Sundaram Fasteners Ltd. The expenditure to be deducted under section 35(1)(iv) should be incurred on scientific research carried on by the assessee or on his behalf. Under section 35(1)(iv ) read with section 35(2)(i)(a ), 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) has got to be understood in the context of the method of accounting followed by the assessee. In the instant case, the assessee was following mercantile system of accounting. It was not disputed in the present case that machineries and equipments transferred to 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. The assessee can also transfer its machineries for the purpose of scientific research and development. The assessee can also provide in cash or in kind for scientific research and development for the advancement of its business. There is no prohibition in section 35(1)(iv) for transferring a part of the assets of assessee-company towards scientific research and development. Setting apart machineries for scientific research and development is also transfer of assets for scientific research and development It is also open to the assessee to get back the machineries 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) and the depreciation under section 32.​​ As the assessee satisfied all the conditions prescribed under section 35(1)(iv ) read with section 35(2), the assessee was entitled to the deduction of its own capital expenditure under section 35(1)(iv).