PCIT’s Revision Upheld as AO’s Failure to Apply Mandatory DSIR Limit is an Error.

ORDER

Siddhartha Nautiyal, Judicial Member.- This appeal has been filed by the Assessee against the order passed by the Ld. Principal Commissioner of Income Tax, (in short “Ld. PCIT”), Vadodara-1 vide order dated 23.02.2024 passed for A.Y. 2018-19.

2. The assessee has raised the following grounds of appeal:

“1. In law and in the facts and circumstances of the Appellant’s case, the ld. PCIT grossly erred in not appreciating that in order to invoke the section 263 of the income Tax Act, 1961 (for short “the Act”) two conditions must be fulfilled viz. the impugned assessment order must be erroneous and that error must be prejudicial to the interest of revenue. In the Appellant’s case ld. AO has passed the assessment order after analyzing all primary details and therefore there was no error in the impugned assessment order so as to justify action u/s 263 of the Act. In the case of Appellant, the very assumption ofpower u/s 263 of the Act is unjustified and bad in law and therefore, order u/s 263 of the Act deserves to be quashed.

2. In law and in facts and circumstances of the Appellant’s case, the ld. PCIT erred in passing revisional order dated 23-02-2024 under section 263 of the Act only on the surmises, conjecture and whims that ld. Assessing Officer has not take the cognizance of material filed during the course of Assessment proceeding which is bad in law.

3. In law and in facts and circumstances of the Appellant’s case, the finding of Id. PCIT that ld. Assessing Officer has passed the order u/s 143(3) of the Act on 0604-2021 without making necessary inquiry and without carrying out due diligence in regard deduction claimed under section 35(2AB) of the Act is set aside and ld. PCIT has exceeded her jurisdiction to examine the issue. Thus, the order passed is void and bad in law.

4. In law and in facts and circumstances of the Appellant’s case, the ld. PCIT has failed to appreciate that amendments to Rule 6(7A) of Income Tax Rules would not over-ride the provision of section 35(2AB) of the Act and that the provision of the section there is no specific condition of restricting the limit as per Form no 3CM and thus assessment order passed was not prejudicial to interest of revenue and erroneous and thus the ld. PCIT has exceeded her jurisdiction to examine the issue. Thus, the order passed is void and bad in law.

5. In law and in facts and circumstances of the Appellant ‘s case the ld. PCIT has failed to appreciate that Income Tax Rules are notified for effective implementation of the provision of the Act and that the former does not have over-riding effect to the letter. The observation of the ld. PCIT to apply rules over the provision of the Act is arbitrary and against the settled position of the law and thus directing to carry out disallowance based on rules is exceeded her jurisdiction to examine the issue. Thus, the order passed is void and bad in law.

6. The Appellant craves leave to add, amend, alter or delete any of the above grounds of appeal. “

3. The brief facts of the case are that the assessee, M/s. Pharmanza Herbal Private Limited, filed its return of income for Assessment Year 2018-19 on 29.11.2018, declaring total income of ?4,81,57,700/-. The assessment was completed under section 143(3) read with sections 143(3A) and 143(3B) of the Income-tax Act, 1961 (Act), on 16.04.2021, accepting the returned income.

4. Upon examination of the assessment records, the Principal Commissioner of Income Tax (Pr. CIT) found that the assessee had claimed a deduction under section 35(2AB) of ?1,80,11,055/-, being 150% of the R&D expenditure of ?1,20,07,370/- incurred on its in-house research and development facility. The Pr. CIT observed that under Rule 6(7A) of the Income-tax Rules, 1962, as amended w.e.f. 01.07.2016, the prescribed authority (the Secretary, Department of Scientific and Industrial Research -DSIR) is required to quantify the expenditure eligible for weighted deduction under section 35(2AB) in Part B of Form 3CL. Upon perusal of Form 3CL issued by DSIR in the assessee’s case, it was noticed that the DSIR had approved only ?112.25 lakh as eligible R&D expenditure for the relevant year. Accordingly, the deduction allowable under section 35(2AB) worked out to ?1,68,37,500/- (150% of ?112.25 lakh), whereas the Assessing Officer had allowed ?1,80,11,055/- thus resulting in an excess allowance of ?11,73,555/-. The Pr. CIT noted that the Assessing Officer had failed to verify the claim of deduction in light of the amended provisions of Rule 6(7A) and the quantification by DSIR, and therefore allowed excess deduction in contravention of law. Referring to the twin conditions laid down by the Hon’ble Supreme Court in Malabar Industrial Co. Ltd. v. CIT ITR 83 (SC) that for invoking section 263, the order must be both erroneous and prejudicial to the interests of the Revenue the Pr. CIT held that both conditions stood satisfied in this case. The Assessing Officer’s omission to restrict the deduction to the DSIR-approved amount rendered the order erroneous and prejudicial to revenue.

5. In response to the show cause notice issued under section 263, the assessee contended that (i) the Assessing Officer had verified the claim in detail, (ii) section 35(2AB) of the Act did not mandate DSIR quantification for deduction, (iii) in case of any discrepancy, unapproved R&D expenses were allowable under section 37, and (iv) since two views were possible, revision under section 263 was unwarranted in view of the principle laid down by the Hon’ble Supreme Court in CIT v. Max India Ltd. ITR 282 (SC) and NDTV v. ACITITR 607 (SC)/Civil Appeal No. 1008 of 2020. The Pr. CIT rejected the assessee’s contentions, holding that after the Finance Act, 2015 amendment effective from 01.04.2016, both section 35(2AB) and Rule 6(7A) explicitly required quantification of eligible R&D expenditure by the DSIR in Form 3CL. Hence, there was no scope for dual interpretation or alternate views. The Pr. CIT referred to the assessee’s own earlier cases before the ITAT Ahmedabad Bench in Pharmanza Herbal (P.) Ltd. v. Dy. CIT ITD 159 (Ahmedabad – Trib.)/ ITA Nos. 468 & 469/Ahd/2022 (A.Ys. 2014-15 and 2015-16), where the Tribunal held that quantification by DSIR became mandatory only after 01.04.2016, and that those years being pre-amendment periods, the DSIR’s quantification was not required. However, the Pr. CIT noted that the present year (A.Y. 2018-19) clearly fell under the post-amendment regime, and hence, the DSIR quantification was binding. The Pr. CIT further cited the principle laid down by the ITAT in Mrs. Khatiza S. Oomerbhoy v. ITO [2006] 100 ITD 173/101 TTJ 1095 (Mumbai) and by the ITAT Kolkata in Britannia Industries Ltd. v. Pr. CIT [IT Appeal No. 150(Kol) of 2021, dated 28-3-2022], emphasizing that an order passed on an incorrect assumption of facts or incorrect application of law is “erroneous,” and an order passed without due inquiry or application of mind is also liable to revision under section 263. Applying these principles, the Pr. CIT held that the Assessing Officer had passed the assessment without proper inquiry and contrary to statutory provisions. Principal CIT further observed that the assessee’s reliance on the principle that “the Act prevails over the Rules” was misplaced, since there was no conflict between section 35(2AB) and Rule 6(7A); rather, the Rule merely prescribed procedural conditions to operationalize the section. PCIT also made reference to the Finance Act, 2015 amendment substituting the requirement of an agreement with DSIR by the obligation to “fulfil such conditions with regard to maintenance of accounts, audit, and furnishing of reports,” thereby linking it directly to the quantification procedure prescribed under Rule 6(7A). In light of these facts and the binding legal position, the Pr. CIT concluded that the Assessing Officer had erroneously allowed an excess deduction of ₹11,73,555/- under section 35(2AB), without considering the DSIR’s quantified expenditure in Form 3CL, thereby causing prejudice to the interests of the Revenue. Accordingly, invoking powers under section 263 of the Act, and following judicial precedents including Malabar Industrial Co. Ltd. (supra) and CIT v. Gabriel India Ltd.203 ITR 108 (Bom.), the Pr. CIT held that the assessment order dated 16.04.2021was erroneous and prejudicial to the interest of the Revenue.

6. The assessee is in appeal before us against the order passed by CIT(Appeals) dismissing the appeal of the assessee.

7. Before us, the ld. counsel for the assessee primarily reiterated the submissions made before Principal CIT(Appeals). In response, Ld. DR placed reliance on the observations made by Principal CIT in the 263 order.

8. We have heard the rival contentions and perused the material on record. It would be useful to refer to some recent case laws on the subject. In the case of FDC Ltd. v. Pr. CIT [2023] (Mumbai – Trib.)[02-08-2023], ITAT held that Assessment order passed by Assessing Officer allowing deduction under section 35(2AB) of the Act without obtaining Form 3CL was erroneous and prejudicial to interest of Revenue. While passing the order for assessment year 2018-19, ITAT made the following observations:

“6. With regard to the deduction allowed u/s 35(2AB) of the Act, the case of the Ld PCIT is that the same has been allowed without obtaining approval in Form 3CL. The Ld A.R submitted that the above said Form 3CL has to be furnished by the prescribed authority directly to the Principal Chief Commissioner of Income-tax or Chief Commissioner of Income-tax and the assessee cannot furnish the same. Accordingly, it was contended that the assessee cannot be foundfault with if the Form 3CL was not given by the prescribed authority.

7. However, on a perusal of Rule 6(7A)(b) would show that the said rule prescribes certain condition, which inter alia, includes quantification of Expenditure eligible for deduction u/s 35(2AB) of the Act in Form 3CL. Even though it is not the responsibility o£the assessee to furnish above said form_±yet it is the requirement prescribed in Rule 6(7A), which should have been examined by the AO before allowing deduction u/s 35(2AB) of the Act. We noticed earlier that the assessing officer had asked the assessee through the notice issued u/s 142(1) of the Act about the break-up details of expenses only and did not mention about Form 3CL. Even though the above said form has to be furnished by the prescribed authority directly to the PCCIT/CCIT, yet it is the responsibility of the AO to verify as to whether the requirement of Rule 6(7A) has been satisfied or not, before allowing the claim u/s 35(2AB) of the Act. Admittedly, the AO has not examined the same.

8. The Ld A.Rplaced his reliance on the decision rendered by Hon’ble Gujarat High Court in the case of CIT v. Sun Pharmaceutical Industries Ltd. and certain other decisions in order to contend that the assessee cannot be penalized if the prescribed authority did not send Form 3CL to the revenue. However, we notice that the above said decisions have been rendered for the years prior to the amendment of rule 6(7A)(b) of the Act, which now requires examination of Form 3CL before allowing deduction u/s 35(2AB) of the Act. Hence, we are of the view that the above said decisions cannot be taken support of for the year under consideration.

9. The Ld A.R also contended that the above said amendment has been made only in the Rules and not in the substantive provisions and hence, the said amendment in the Rules cannot disentitle the assessee from claiming deduction for want of Form 3CL. We notice that the provisions of sec.35(2AB)(3) of the Act was amended with effect from 1-4-2016 by Finance Act, 2015, wherein it is stated that the assessee should fulfill such conditions with regard to maintenance of accounts and audit thereof and furnishing of reports in such manner as may be prescribed. We notice Rule 6(7A) was amended w.e.f 1-7-2016, i.e., after the amendment made in Sec. 35(2AB)(3) of the Act. Further, Form 3CL is one of the forms prescribed in Rule 6(7A)(b) of the Rules for quantifying scientific research expenditure by the prescribed authority. Since the rules prescribe for examination of the above said form, it is the duty of the AO to verify the same before allowing the deduction u/s 35(2AB) of the Act. Admittedly, the AO has not examined this aspect, even though it is not a fault upon the assessee.

10. Hence, we agree with the view taken by LdPCIT on this issue that the AO has not carried out due enquiries or verification with regard to this issue. Accordingly, we uphold the order passed by Ld PCIT on this issue. “

9. In the case of Gujarat Metal Cast Industries (P.) Ltd. v. Pr. CIT ITD 178 (Ahmedabad – Trib.)[01-04-2025], the Assessee claimed deduction under section 35(2AB) of the Act on account of in-house research and development expenditure. The Assessing Officer allowed said claim. Subsequently, Principal Commissioner invoked jurisdiction under section 263 on ground that deduction under section 35(2AB) was allowed without verifying whether assessee submitted Form 3CL from prescribed authority and that too at rate of 200 per cent whereas applicable rate as per amended provision was 150 per cent from 01.04.2018. The ITAT held that provisions of section 35(2AB) read with Rule 6 clearly mandate filing of Form 3CL and limit weighted deduction to 150 per cent of eligible expenditure incurred on in-house research and development from assessment year 2018-19 onwards. Therefore, since Assessing Officer allowed deduction at 200 per cent in clear contravention of law, and without verifying whether basic condition of submission of Form 3CL by DSIR quantifying eligible expenditure had been fulfilled, Principal Commissioner was justified in invoking revisionary powers under section 263 and setting aside assessment order with a direction to Assessing Officer to frame a fresh assessment after conducting proper verification and affording reasonable opportunity to assessee.

10. Now coming to the present facts, the undisputed facts of the case show that the assessee had claimed deduction under section 35(2AB) of the Act, amounting to ?1,80,11,055/-, being 150% of its in-house R&D expenditure of ?1,20,07,370/-, whereas the prescribed authority, i.e., DSIR, had approved only ?112.25 lakh as eligible R&D expenditure in Form 3CL. Consequently, the deduction allowable under section 35(2AB) ought to have been restricted to ?1,68,37,500/-, but the Assessing Officer, without verifying the DSIR quantification, allowed the full claim made by the assessee. The Principal CIT, after detailed examination, rightly invoked the provisions of section 263 on the ground that the assessment order passed by the Assessing Officer was both erroneous and prejudicial to the interests of the Revenue. We find that post the amendment brought by the Finance Act, 2015, effective from 01.04.2016, and the corresponding amendment in Rule 6(7A) of the Incometax Rules, 1962, effective from 01.07.2016, the quantification of eligible R&D expenditure by DSIR in Part B of Form 3CL has become a mandatory precondition for the purpose of claiming weighted deduction under section 35(2AB). Thus, the Assessing Officer is duty-bound to restrict the deduction to the extent of expenditure approved and quantified by DSIR. Failure to do so renders the assessment order erroneous and prejudicial to the interests of the Revenue within the meaning of section 263 of the Act. The reliance placed by the assessee on the decision of the Hon’ble Supreme Court in Max India Ltd.(supra) is misplaced since the statutory amendments made post 01.04.2016 have removed any ambiguity and there is no longer any scope for two possible views on this issue. Similarly, the decision of the Hon’ble Supreme Court in NDTV (supra), has no application to the facts of the present case where the legal position stands settled and the Assessing Officer has failed to make the necessary verification mandated by law. In this regard, we draw support from the decision of the Mumbai Bench of the Tribunal in FDC Ltd.(supra) wherein it was held that failure of the Assessing Officer to examine whether Form 3CL had been issued by DSIR and to verify the quantification of expenditure in accordance with Rule 6(7A) renders the assessment order erroneous and prejudicial to the interest of the Revenue. The Tribunal categorically observed that even though furnishing of Form 3CL is the responsibility of the prescribed authority, it is incumbent upon the Assessing Officer to verify its existence and contents before granting deduction under section 35(2AB) of the Act. Further, in the recent decision of the Ahmedabad Bench of the Tribunal in Gujarat Metal Cast Industries (P.) Ltd(supra), it was held that the provisions of section 35(2AB) read with Rule 6(7A) clearly mandate that the deduction be restricted to 150% of the amount approved in Form 3CL from Assessment Year 2018-19 onwards, and any allowance of higher deduction or allowance without verification of Form 3CL constitutes a clear contravention of law justifying exercise of revisionary powers under section 263.

11. In the present case, the assessment order was passed without verification of the DSIR quantification and in disregard of the binding provisions of law as amended. Therefore, we find no infirmity in the action of the Principal Commissioner of Income Tax in invoking his revisionary jurisdiction under section 263 of the Act. The contention of the assessee that the Assessing Officer had made adequate enquiry is devoid of merit, as mere calling for details of expenditure does not amount to verification of statutory compliance under Rule 6(7A). Accordingly, following the ratio laid down by the Hon’ble Supreme Court in Malabar Industrial Co. Ltd. (supra) and by the Hon’ble Bombay High Court in Gabriel India Ltd. (supra), and in light of the coordinate bench decisions in FDC Ltd. (supra) and Gujarat Metal Cast Industries (P.) Ltd. (supra), we hold that the order passed by the Assessing Officer dated 16.04.2021 is erroneous and prejudicial to the interests of the Revenue. We therefore uphold the order passed by the Principal Commissioner of Income Tax under section 263 of the Act.

12. The appeal filed by the assessee is dismissed.