Background:

Section 35(2AB) of the Act¹ grants weighted deduction to specified companies² subject to compliance with conditions as laid down in the section, Rules³ and in the DSIR⁴ guidelines.  Weighted deduction is granted for capital and revenue expenditure (except for cost of land or building) incurred directly on scientific research facility⁵ which has been recognised and approved by the DSIR. Further, a company is also required to file annually with the DSIR a certificate certifying claim of weighted deduction.

In order to ensure better and meaningful monitoring mechanism, the previous Budget amended Section 35(2AB)(4) requiring DSIR to share their report approving the facility with the “Pr. CCIT⁶ or CCIT⁷” having jurisdiction over the assessee company. Recently CBDT⁸ vide notification dated 28 April 2016 has amended Rule 6 and notified the forms for claiming weighted deduction.

Analysis of key amendments as notified in the Rule 6 are summarised as under:

a) DSIR to furnish electronically, report approving the facility to the “Pr. CCIT or CCIT or DGIT⁹ or DGIT¹⁰” (prescribed authorities) having jurisdiction over the company in form 3CM within 120 days from the date of granting of approval by DSIR (as against earlier time limit of 60 days).

b) The erstwhile Rule and DSIR guidelines did not prescribe any time limit for issuing the report approving the claim of expenditure eligible for weighted deduction. Thus in past, where report approving the expenditure was received after due date for filing revised return had lapsed, companies faced challenges in substantiating the claim made in the tax return, vis-à-vis claim approved by DSIR, during assessment proceedings. This also resulted into unwarranted litigation since revised claim for deduction was made during assessment proceedings without filing revised return. There was always a potential risk of reopening the concluded assessments, if DSIR report was received after completion of the assessment. Thus prescribing time line of 120 days from the date of submission of audit report to quantify the expenditure is a welcome step. This would also assist companies to revise their claim by filing revised return.

c) DSIR to electronically inform the prescribed authorities having jurisdiction over the company, about expenditure approved in Form 3CL.

d) Revised rules have also made changes to audit report required to be furnished. Relevant changes made in relation thereto are summarised as under:

e) Amendments prescribed in revised Rule are applicable with effect from 1^st July, 2016. Thus all companies claiming weighted deduction for AY 2016-17 onwards would require compliance with the revised rules. There is no clarity whether compliance as per revised rule would also apply to assessment years prior to AY 2016-17 where the approval of facility by DSIR is delayed and received post applicability of revised Rules.

Other related issues:

a) There is no mandate on DSIR both under the old and amended Rules to furnish reasons for rejecting the claim of weighted deduction. As a consequence, companies face challenges in identifying the expenses rejected by the DSIR and also defending penalty that is levied on such rejected claims. Unless cogent reasons for rejecting the claim are known, it also becomes difficult for the Appellate Authorities to adjudicate such claims. Thus following principles of natural justice, DSIR should be mandated to provide appropriate justification for rejecting the claim.

b) A question which is also debated, is whether role of DSIR is restricted to approval of facility or it also extends to determining the quantum eligible for weighted deduction. A strict reading of section 35(2AB) of the Act along with the Explanatory Memorandum and Notes to clauses to Finance Bill 1997 which introduced the section together with certain judicial precedents ([TS-5260-HC-2013(GUJARAT)-O] and [TS-5640-ITAT-2009(AHMEDABAD)-O] suggest that it is only  the facility that requires approval by DSIR and not the expenditure incurred on such facility. On the contrary, certain decisions [TS-738-ITAT-2012(HYDERABAD)-O] and [TS-5780-HC-2015(Karnataka)-O] hold that DSIR is the final authority to decide on the nature and quantum of expenditure entitled to weighted deduction.

As much of the filing and procedural requirements which were earlier prescribed by the DSIR guidelines have now been incorporated in the Rule, this would strengthen acceptability of the DSIR as a final authority for even approving the expenditure eligible for weighted deduction.

Ideally the role of DSIR should be restricted only to approving the facility and DSIR should become functus officio where the question of quantum of deduction is involved. Entire claim of expenditure should be considered as qualifying for weighted deduction. Only in exceptional cases where there is evidence of tax avoidance or genuineness of the research undertaken is in doubt, the AO¹² should have right to challenge the claim of deduction.

Thus appropriate clarification may be inserted in the Act onthe position and functions of DSIR to avoid protracted litigation and achieve certainty.

(Views expressed are personal)

Glossary

1. Act - Income-tax Act, 1961

2. Specified companies – Companies engaged in business of bio-technology or in any business of manufacture of any article or thing (other than those specified in the eleventh schedule)

3. Rules - Income-tax Rules, 1962

4. DSIR - Department of Scientific and Industrial Research

5. Facility - In-house R&D facility

6.CCIT - Principal Chief Commissioner of Income-tax

7. CCIT - Chief Commissioner of Income-tax

8. CBDT - Central Board of Direct Taxes

9. DGIT - Principal Director General of Income-tax

10. DGIT - Director General of Income-tax

11. AO - Assessing Officer