Allocation of Employee Benefit Expenses to Agricultural Activities Upheld Due to Nature of Work

I. Allocation of Employee Benefit Expenses to Agricultural Activities Upheld Due to Nature of Work

Issue:

Whether the Assessing Officer (AO) was justified in allocating employee benefit expenses to agricultural activities on a proportionate basis, when the assessee claimed a much lower allocation, and the nature of the agricultural activity was specialized and labor-intensive.

Facts:

For the assessment year 2018-19, the assessee was engaged in manufacturing bio-fertilizers and pesticides, and also had agricultural activities. The Assessing Officer (AO) examined the allocation of various expenses between agricultural and non-agricultural activities, finding the assessee’s allocation lacked a rational basis. The AO then re-worked the allocation, specifically allocating employee benefit expenses towards agricultural activities. The assessee contended that only 8 employees were deployed for agricultural activities, while 81 employees worked in the bio-division. However, given the specialized and labor-intensive nature of the agricultural activity (implied to be significant over an area of 18512 sq. mt.), the salary expenses and daily wages allocated by the assessee to this activity seemed disproportionately low compared to the total employee benefit expense.

Decision:

Yes, the court held that given the specialized and labor-intensive deployment of manpower in agricultural activity, the salary expenses and daily wages as allocated to agricultural activity was too low, considering the total employee benefit expense incurred. Thus, the allocation of employee benefit expense on a proportionate basis, as done by the Assessing Officer, was upheld.

Key Takeaways:

• Rational Basis for Expense Allocation: When an assessee engages in both taxable and exempt (e.g., agricultural) activities, common expenses must be allocated between them on a rational and justifiable basis.
• Reality of Operations: The nature and scale of the activity (specialized, labor-intensive, large area) should dictate the reasonableness of expense allocation. A disproportionately low allocation of manpower costs to a labor-intensive activity may be rejected.
• AO’s Power to Reallocate: If the assessee’s allocation is found to be irrational, the AO has the power to reallocate expenses on a reasonable basis, and such reallocation will be upheld if justified by the facts.
• In Favor of Revenue: This specific point of contention was decided in favor of the revenue, upholding the AO’s higher allocation of employee benefit expenses to agricultural income (which is exempt).

II. Finance Costs Not Allocable to Agricultural Activities if Assessee Has Sufficient Own Funds

Issue:

Whether finance costs should be allocated towards agricultural activities when the assessee has its own substantial surplus funds from agricultural activities and accumulated funds from past years, as well as fresh capital like share premium, without evidence that borrowed funds were utilized for agricultural operations.

Facts:

For the assessment year 2018-19, the assessee had agricultural activities. The Assessing Officer (AO) allocated finance costs (interest expenses) towards these agricultural activities. However, it was noted that the assessee already had a surplus from agricultural activity and had accumulated funds from past years. Furthermore, a sum of ₹2.10 crores was received by the assessee during the year on account of share premium, which was also available for agricultural operations. The AO did not bring any evidence on record to show that borrowed funds were specifically utilized for agricultural operations.

Decision:

Yes, the court held that since the assessee had its own surplus funds and the Assessing Officer had not brought any evidence on record that borrowed funds were utilized for agricultural operations, the allocation of finance cost towards agricultural operation was not called for.

Key Takeways:

• Direct Nexus for Finance Costs: For finance costs (interest on borrowed funds) to be disallowed under Section 14A (if related to exempt income) or allocated to an exempt activity (like agriculture), there must be a direct nexus between the borrowed funds and the exempt activity.
• Availability of Own Funds: If the assessee has sufficient own funds (e.g., accumulated profits, share premium) to cover the investment or working capital needs of the exempt activity, a presumption arises that such own funds were used first, not borrowed funds.
• AO’s Burden to Prove Utilisation: The burden is on the Assessing Officer to bring evidence on record to establish that borrowed funds were indeed utilized for the exempt agricultural operations to justify the allocation of finance costs to it.
• In Favor of Assessee: This point was decided in favor of the assessee, reducing the disallowance or allocation of finance costs to agricultural income.

III. Depreciation/Amortization Disallowance on Agricultural Assets Remanded for Verification

Issue:

Whether the disallowance of depreciation and amortization expenses allocated to agricultural activities is justified when the assessee claims to have already disallowed it, but the details of assets deployed for agricultural activities are not clearly appearing in the audited annual accounts.

Facts:

For the assessment year 2018-19, the assessee had agricultural activities. The Assessing Officer (AO) disallowed depreciation and amortization expenses, presumably allocated towards agricultural activities, after finding that the assessee’s general expense allocation lacked a rational basis. The assessee contended that it had already disallowed depreciation in respect of agricultural activities. However, it was noted that the details of assets specifically deployed for agricultural activities were nowhere clearly appearing in Schedule-3 of the audited annual accounts.

Decision:

Yes, the court held that the matter was to be remanded back to the Assessing Officer to verify the assets deployed for agricultural operation and, thereafter, disallow depreciation only on those assets which were actually utilized for agricultural activities.

Key Takeaways:

• Depreciation for Agricultural Assets: While agricultural income is exempt, depreciation on assets used exclusively for agricultural operations is also typically related to that exempt income and may not be allowable against taxable income.
• Clear Identification of Assets: For proper accounting and tax treatment, assets deployed for agricultural activities should be clearly identified and accounted for, separate from assets used for taxable business.
• AO’s Duty of Verification: When there is a dispute or lack of clarity regarding the specific assets used for an exempt activity, the AO has a duty to conduct a proper verification before making a disallowance.
• Remand for Factual Verification: The remand ensures that a fair and accurate determination is made regarding the depreciation allowable, based on the actual utilization of assets.

IV. Allocation of Other Expenses to Agricultural Activities: Only Directly Related Expenses to be Allocated

Issue:

Whether certain common/indirect expenses (like packing material, freight, Director’s remuneration, legal/professional, rent, insurance) should be allocated towards agricultural activity, and if the AO’s proportionate allocation based on revenue from agricultural operations to total revenue is correct.

Facts:

For the assessment year 2018-19, the assessee was engaged in manufacturing bio-fertilizers and pesticides, and also cultivated “Mycorrhizal Fungal Infected Root,” which was used for manufacturing bio-fertilizers. The Assessing Officer (AO) re-worked the allocation of certain common/indirect expenses towards agricultural activity, using a proportionate basis linked to revenue from agricultural operations to total revenue. The assessee contended that packing material expense, freight and forwarding expense, Directors’ remuneration, etc., were not incurred for agricultural activities at all.

Decision:

Yes, the court gave a mixed ruling:

• Since the entire agricultural produce was sold to five different parties, packing material expense and freight and forwarding expense were required to be allocated to agricultural activities (as they are directly linked to the sale of produce).
• However, legal and professional expenses, rent, insurance, and other expenses, which were not at all related to agricultural activities, were not required to be allocated towards agricultural operation.
• Thus, the matter was set aside to the Assessing Officer with a direction to verify expenses that had a connection with agricultural operation and thereafter allocate only those expenses that had a bearing on the agricultural operation of the assessee.

Key Takeaways:

• Direct Nexus for Common Expenses: Common expenses should only be allocated to an exempt activity (like agriculture) if there is a direct and demonstrable nexus between the expense and that activity.
• Purpose of Expense: The purpose for which an expense is incurred is paramount. Packing and freight are directly linked to the sale of agricultural produce. However, general legal and professional expenses, rent, or insurance (unless specifically for agricultural assets/property) might not be.
• No Blanket Proportionate Allocation: The AO cannot simply apply a blanket proportionate allocation (based on revenue) for all common expenses. Each expense head needs to be examined to see its actual connection to the exempt activity.
• Remand for Item-wise Verification: The remand directs the AO to conduct an item-wise verification of expenses to determine which ones truly have a “bearing” on the agricultural operation.

V. Section 80JJA Deduction: Remanded for Verification of Business Commencement Date and Lenient View on Late Return Filing

Issue:

Whether deduction under Section 80JJA (profits and gains from business of collecting and processing bio-degradable waste) can be denied solely because the return was not filed within the due date prescribed under Section 139(1), particularly when Section 80AC (requiring timely return filing for Chapter VI-A deductions) was a relatively new procedural requirement for that year. Also, whether the assessee’s eligibility for the deduction within the five-year period from business commencement needs verification.

Facts:

For the assessment year 2018-19, the assessee claimed deduction under Section 80JJA. The Assessing Officer (AO) disallowed this claim on the sole ground that the return of income was not filed within the due date prescribed under Section 139(1).

Decision:

Yes, the court gave a mixed ruling and remanded the matter:

• Since the provision of Section 80AC (which stipulated that deduction was admissible only if the return was filed on or before the due date specified under Section 139(1)) was only a procedural requirement, and the change in statute was effected from this year only, the Assessing Officer was directed to take a lenient view in the matter and allow the deduction, if otherwise admissible.
• However, since it was not evident from the return that the claim of deduction under Section 80JJA for this year was within the prescribed period of five years from the date of commencement of business and nothing had been brought on record by the assessee in this regard in the course of the appeal proceeding as well, the matter was remanded back to the Assessing Officer for examination of this specific point.

Key Takeaways:

• Section 80AC (Timely Return Filing): This section mandates that for certain Chapter VI-A deductions (including 80JJA), the return of income must be filed by the due date specified under Section 139(1). Failure to do so leads to disallowance.
• Lenient View for New Procedural Requirements: Courts sometimes take a lenient view regarding strict procedural compliance when a statutory change (like the introduction of 80AC’s strictness) is relatively new for the relevant assessment year, especially if the assessee’s underlying claim is genuine.
• Substantive Conditions for 80JJA: Section 80JJA grants deduction for profits from the business of collecting and processing bio-degradable waste, but it is available for a limited period (e.g., five consecutive assessment years from commencement of business). This is a substantive condition.
• Assessee’s Burden: The assessee must prove that they meet all substantive conditions for claiming a deduction, including the commencement date of business for the five-year period.
• Remand for Factual Verification: The matter was remanded to allow the AO to verify the specific details of the business commencement date and its relation to the five-year claim period, which was not clearly evident from the record. This ensures both procedural fairness and substantive compliance.