The Hindu Business Line : Expenditure eligible for deduction

The word ‘industrial’ was omitted by Finance Act, 2008. Deduction is now available up to one-fifth of the expenditure for five successive previous years.

T. C. A. Ramanujam

Tax law allows deduction for expenditure incurred in connection with the setting up of an industrial unit by a resident Indian or an Indian company. The expenditure should have been incurred before the commencement of the business or in connection with the extension of the undertaking after the commencement of the business.

Deduction liberalised

The deduction was previously allowed to the extent of one-tenth of the expenditure for 10 successive previous years on the commencement of the business. The provision was liberalised w.e.f. April 1, 2009 by the Finance Act, 2008. The deduction is allowable even for non-industrial units or undertaking w.e.f. April 1, 2009.

The word ‘industrial’ was omitted by Finance Act, 2008. Deduction is now available up to one-fifth of the expenditure for five successive previous years. Expenditure covered under Section 35D of the Income-Tax Act, 1961 related to preparation of feasibility and project reports, market survey and engineering services and also legal charges.

A limit is placed on the expenditure to be considered for deduction. The aggregate amount of expenditure under Section 35D should not exceed 5 per cent of the cost of the project or of the capital employed in the business of the company. The Explanation to Section 35D(3) defines the ‘cost of the project’ — actual cost of fixed assets will also be considered.

Long-term borrowing

There is also a definition of ‘capital employed in the business of the company’. This relates to the issued share capital, debentures and long-term borrowings. Section 35D(3)(c) defines ‘long-term borrowings’ in two alternative ways.

First, it means monies borrowed from government, the Industrial Finance Corporation of India, ICICI or any other financial institution which are eligible for deduction under Section 36(1)(viii) or any banking institution.

Second, ‘long-term borrowings’ can also mean monies borrowed or debt incurred in a foreign country in respect of purchase outside India of capital plant and machinery where the terms provide for repayment during a period of not less than seven years.

Bridge loan

Core Healthcare Ltd took bridge loans from the IFCI and the ICICI. The assessing officer (AO) disallowed the claim under Section 35D in respect of the cost of the project and the expenditure calculated thereon.

He took the view that the expenditure in question was in the capital field and will not fall for consideration as capital employed for computing relief under Section 35D. The appellate authorities did not agree with the view of the AO. The Income-Tax Appellate Tribunal (ITAT) ruled that Section 35D did not make distinction between short-term and long-term borrowings. No period was prescribed. The bridge loan was considered as part of capital employed for purposes of working out deduction under Section 35D.

The Revenue took up the matter in appeal. The High Court extracted the definition of long-term borrowings as given in Explanation to Section 35D. On a plain reading it was apparent that the borrowing has to be from one of the four entities mentioned in Explanation (c)(i).

No time limit for the purposes of borrowing is laid down in the provision. Compare the same with Explanation (c)(ii) which gives an alternate definition. Here it is laid down specifically that the borrowing should be for a period of not less than seven years.

This however refers to debt incurred in a foreign country. The High Court pointed out that once it is established that the borrowing is from any one of the four entities specified therein, the same would be treated as long-term borrowings for working out the aggregate of capital employed in the business. The lower appellate authorities rightly came to the conclusion that the amount in question was required to be included for calculating capital employed in the business (308 ITR 263).

High Court rulings

There have been authoritative rulings of High Courts on the question of amortisation of expenditure on public issue of share and stamp duty. These were in favour of the taxpayer.

But courts have also held that fees paid for increase in share capital, management fees and lease rent and share premium collected by the company on the subscribed share capital will not form part of Section 35D.

On the other hand, expenditure incurred towards raising money by way of debenture issues for expansion activity of the company was considered eligible for deduction under Section 35D.

Deduction is allowed for expenditure which may otherwise be disallowed on the ground that it is of capital nature or was incurred prior to the setting up of the business. Section 35D will not recognise expenditure which is allowable as revenue. Expenditure on advertisement and sales promotion will be eligible under the category of market survey or any other survey necessary for business. Rule 6AB prescribes the form of audit which is required to be furnished under Section 35D.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)

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