The Hindu Business Line : Amortisation of preliminary expenses

Questions often arise whether such expenses can be claimed as revenue in nature. If it is revenue expenditure, it can be allowed as a deduction under Section 37 of the Income-Tax Act, 1961.

Revenue expenditure

If it is not considered as revenue in nature, then it will have to be taken as capital expenditure which can be amortised over a period of years.

It is not that every type of capital expenditure falls in this category. The expenses which can be amortised are specified in Section 35D of the I-T Act.

Expenses in connection with preparation of feasibility reports, project report, survey necessary for the business of the assessee or on engineering services, legal charges, printing of memorandum, registration fees, public issue expenses, etc., relating to the business can all be amortised. Stringent conditions are laid down for claiming amortisation. The expenditure should not exceed 5 per cent of the ‘project cost’ or the ‘capital employed’.

These terms are also defined in the I-T Act. Deduction as revenue expenditure under Section 37 is somewhat more liberal. There can be situations when a claim can fall for consideration both under Section 35D and Section 37. This can arise in the case of a running company.

Claims under two Sections

Shree Synthetics Ltd was engaged in the business of manufacture of synthetic fibre, yarn fabrics, etc. It undertook modernisation and expansion of spinning line, nylon polymerisation, etc. For financing the expansion, the company raised money by way of issuance of debentures, partly convertible and partly nonconvertible.

The debenture issued resulted in an expenditure of Rs 22.18 lakh. The company claimed that the amount should be allowed under Section 37 as revenue expenditure incurred for raising a loan for running the business.

The assessing officer (AO) took the view that the expenditure squarely fell within the ambit of Section 35D. The matter was taken to the High Court by the company. It was argued that Section 35D referred to ‘extension’ of the industrial undertaking and extension was different from expansion.

The claim for deduction under Section 37 should have been allowed, it was contended, at least with regard to the expenditure relating to the nonconvertible portion of debenture as it represented borrowing of funds.

Extension vs expansion

The MP High Court (in 303 ITR) considered the matter in some detail; it observed that the word ‘extension’ for the purpose of Section 35D also included ‘expansion’ of the industrial undertaking. Expenditure incurred whether for extension or expansion will fall for consideration under Section 35D.

Section 35D is a special provision for claiming deduction of a specified category of expenditure. It excludes the applicability of general provision dealing with revenue expenditure. The special excludes the general. Section 35D will prevail over Section 37.

The High Court was not impressed by the distinction sought to be made between convertible and nonconvertible debentures. The intention behind Section 35D is to include all kinds of debentures under Section 35D.

Amortisation was being allowed over a period of 10 years up to March 31, 1998. After this date, it is allowed over a period of five successive previous years. Under Section 37, the entire expenditure will fall for consideration in one year.

Finance, service companies

Will Section 35D apply in the case of finance and service units? This issue arose in the LIC Housing Finance Ltd case. The company made a public issue of equity shares and incurred a total expenditure of Rs 7,08,51,925 against the public issue of Rs 113.50 crore. It claimed one-tenth of this expenditure under Section 35D.

The Income-Tax Appellate Tribunal (ITAT) rejected the claim on the ground that Section 35D referred to an industrial unit which commenced production or operation. It implies that the industrial undertaking or the unit must be engaged in some manufacturing, producing or processing activity. The only business of the company was that of providing housing finance. This was not covered under Section 35D. The Tribunal was considering the LIC Housing Finance Ltd case in respect of the assessment year 1995-96.

Till recently, amortisation of preliminary expenditure was allowed under Section 35D only for industrial undertakings. It was not applicable to companies engaged in providing finance or other services.

Responding to repeated calls from industry and business, Section 35D was amended by the Finance Act, 2008 w.e.f. April 1, 2009, that is, from the assessment year 2009-10, the benefit of amortisation is available even for service organisations.

The words ‘industrial undertaking’ were omitted and the word ‘undertaking’ was inserted in Section 35D. The benefit of amortisation of specified post-commencement preliminary expenses will henceforth be available to all sectors of industry. The amendment could have been made retrospective.

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