ITAT Mumbai: R&D Building Cost Qualifies for Deduction under Section 35(1)(iv)

1. Background of the Dispute

The Mumbai Bench of the ITAT in Bhansali Engineering Polymers Limited Vs Circle 1(2)(1) examined whether capital expenditure incurred on constructing an in-house Research and Development (R&D) building is eligible for deduction under Section 35(1)(iv) read with Section 35(2) of the Income Tax Act 1961.

The assessee, a listed public company engaged in manufacturing Acrylonitrile Butadiene Styrene (ABS) and Styrene Acrylonitrile (SAN) resins, had:

Filed its original return on 31/10/2018 declaring income of Rs. 149,99,56,200/-.
Filed a revised return on 31/03/2019 declaring income of Rs. 148,87,47,550/-.

The case was picked for complete scrutiny under CASS mainly to verify:

Reduction of income in the revised return and resulting refund claim,
Compliance with ICDS and related adjustments,
Deduction claimed for donation towards scientific research, and
Deductions claimed under Chapter VI-A.

During the scrutiny, the core issue arose around the assessee’s claim of deduction of Rs. 1,12,08,649/- under Section 35(1)(iv) for capital expenditure on construction of its R&D building.

2. Assessment Proceedings and Disallowance

2.1 Assessee’s Claim and Documents Furnished

In response to notices under Section 143(2) and Section 142(1), the assessee furnished details and explanations through various submissions dated 25/12/2020, 05/01/2021, 18/01/2021 and 19/01/2021.

The assessee had claimed:

A deduction of Rs. 1,12,08,649/- under Section 35(1)(iv) towards capital expenditure on construction of an R&D building.
It supported the claim with:
- Approval letter from the Department of Scientific and Industrial Research (DSIR), and
- Bills and supporting documents evidencing the capital expenditure.

2.2 Reasons for Disallowance by the Assessing Officer

The Assessing Officer (AO) did not question the genuineness, quantum, or nature of the expenditure, nor its use for scientific research related to the assessee’s business. However, the AO denied the deduction based on:

Timing of DSIR approval:
- DSIR approval for the R&D facility was granted vide letter dated 27/06/2019 and was valid only from 20/05/2019 to 30/03/2022, i.e., not covering Assessment Year 2018-19.
Non-availability of Form No. 3CL:
- DSIR had not issued Form No. 3CL certifying the amount of expenditure eligible for deduction.

On this basis, the AO:

Added Rs. 1,12,08,649/- back to income by disallowing the Section 35(1)(iv) claim.
Further disallowed Rs. 3,00,000/- under Section 80G, as the assessee did not produce donation receipts and approval details for two donee institutions.

The assessment was completed under Section 143(3) read with Sections 143(3A) and 143(3B) via order dated 13/03/2021, determining total income at Rs. 150,02,56,199/-.

Aggrieved, the assessee filed an appeal before the NFAC (CIT(A)).

3. Proceedings Before CIT(A)

3.1 Assessee’s Core Arguments

Before the CIT(A), the assessee contended that:

DSIR approval is not a condition under Section 35(1)(iv)
- Section 35(1)(iv) only mandates that:
  - expenditure must be capital in nature;
  - it must be incurred on scientific research; and
  - such research must be related to the assessee’s business.
- There is no statutory requirement in Section 35(1)(iv) for DSIR approval of the R&D facility.
Facts on record were undisputed
- The AO had not challenged:
  - the occurrence of the expenditure,
  - its capital character,
  - the use of the building for scientific research, or
  - the nexus between the research and the assessee’s business.
- Therefore, the claim ought not to have been disallowed merely due to later DSIR approval.

Capital expenditure on R&D building allowable under Section 35(1)(iv): ITAT Mumbai clarifies scope of deduction