ITAT Delhi on Disallowance of Bad Debt, R&D Weighted Deduction u/s 35(2AB) and Deduction u/s 80-IA

The Delhi Bench of the Income Tax Appellate Tribunal, in the case of Matrix Clothing Pvt. Ltd. Vs ACIT, dealt with multiple contentious issues arising in the assessment for AY 2021-22, including:

  • Transfer pricing adjustment on loan written off to a foreign subsidiary
  • Claim of weighted deduction under Section 35(2AB)
  • Allowability of expenditure on scientific research under Section 37(1)
  • Eligibility of deduction under Section 80-IA for power generation through windmill
  • Addition of notional interest on interest-free loan to a subsidiary

The Tribunal upheld some major disallowances while granting relief on the Section 80-IA issue by applying the rule of consistency.

Background of the Assessee and Assessment Proceedings

Matrix Clothing Pvt. Ltd. is a company engaged in:

  • Manufacturing and trading of garments, menswear, sportswear and related products
  • Generation of power and energy through windmills

For AY 2021-22:

  • The assessee filed its return of income on 15.03.2022, declaring total income of INR 21,61,874/-
  • Minimum Alternate Tax (MAT) was paid on book profits of INR 2,84,94,002/- under Section 115JB

The case was picked up under CASS. Notices were issued under Section 143(2) and Section 142(1) along with a detailed questionnaire.

Since the assessee had international transactions with its Associated Enterprise (AE), the Assessing Officer (AO) referred the matter to the Transfer Pricing Officer (TPO) under Section 92CA for determination of Arm’s Length Price (ALP).

Key Transfer Pricing Proposal

The TPO, vide order dated 13.10.2022, proposed an adjustment of:

  • INR 53,24,17,100/- on account of loan written off given to the overseas wholly owned subsidiary.

Draft Assessment Order

Subsequently, the AO passed a draft assessment order under Section 144C(1) on 30.12.2023 proposing the following additions/disallowances:

  • Transfer Pricing adjustment on loan written off: INR 53,24,17,100/-
  • Disallowance of Research & Development (R&D) expenses u/s 35(2AB): INR 6,59,31,449/-
  • Disallowance of expenses pertaining to unit eligible for Section 80-IA: INR 42,16,800/-
  • Disallowance of deduction claimed u/s Section 80-IA: INR 21,84,942/-
  • Addition of notional interest on loans to sister concern: INR 30,28,138/-

Total income was proposed to be assessed at INR 60,99,40,303/-.

DRP Directions and Final Assessment

The assessee raised objections before the Dispute Resolution Panel (DRP). Vide order dated 30.09.2024, the DRP:

  • Sustained the TP adjustment relating to loan written off to AE
  • Gave directions for verification/adjustment on other issues

Following DRP directions, the AO passed the final order under Section 143(3) read with Section 144C(13) on 29.10.2024, making additions/disallowances aggregating to INR 60,77,78,429/- and:

  • Recomputed book profit u/s Section 115JB by adding INR 60,77,78,429/-,
  • Resulting in assessed book profit of INR 63,62,72,431/-.

The assessee challenged this final assessment before the ITAT.

Issues Raised Before the Tribunal

The assessee raised multiple grounds, which broadly covered:

  1. Jurisdiction and procedure of the final assessment order
  2. Transfer pricing adjustment on loan written off to the AE (Matrix Clothing Pvt. Ltd. Jordan LLC – “Matrix Jordan”)
  3. Disallowance of deduction u/s Section 35(2AB) for R&D expenditure
  4. Alternative claim of allowance of R&D expenses u/s Section 37(1)
  5. Disallowance of deduction u/s Section 80-IA and related expenditure allocation
  6. Addition of notional interest on interest-free loans to domestic subsidiary

The Tribunal treated Grounds 1 & 2 as general and proceeded to adjudicate the substantive issues.

Transfer Pricing & Bad Debt: Loan Written Off to Overseas Subsidiary

Structure of Overseas Investment

The assessee had incorporated a Special Purpose Vehicle (SPV), Matrix Clothing Pvt. Ltd. Jordan LLC (“Matrix Jordan”) in Jordan, in which it held:

  • 50,000 equity shares of 1 Jordanian Dinar each

Matrix Jordan was set up to acquire Indo Jordan Clothing LLC (Jordan LLC), a company engaged in manufacture and export of garments, in the same line as the assessee.

Between FY 2016-17 and FY 2020-21, the assessee advanced substantial loans to Matrix Jordan:

  • Loans carried interest at LIBOR plus applicable spread
  • Corporate guarantee was also extended by the assessee for working capital facilities obtained by Matrix Jordan

Claim of Loan Written Off

During the year relevant to AY 2021-22, the assessee determined that:

  • Indo Jordan Clothing LLC had become financially unviable
  • There were persistent losses and inability to service principal and interest
  • The assessee decided to dispose of its investment

A share purchase agreement dated 14.02.2021 was executed with United Creations Apparel Manufacturing LLC, transferring the entire shareholding in Indo Jordan Clothing LLC for USD 35,95,025.

On this basis, the assessee claimed:

  • Bad debt/loss of INR 53,24,17,100/- in AY 2021-22 as loan written off to Matrix Jordan
  • Balance loan write-off of INR 22,90,14,404/- in subsequent years

The assessee argued commercial expediency and business purpose behind the loan and its subsequent write-off.

Impact of COVID-19 and Business Failure