Sections 35E, 37(1), Matching concept — Only expenses incurred wholly and exclusively for exploring, locating or proving deposits of any minerals and including expenses on operations which prove to be infructuous or abortive are eligible for amortisation u/s.35E — Matching principle cannot restrict the quantum of deduction of expenses by relating the same to quantum of earnings as a result of incurring these expenses.
Facts:
The assessee, engaged in the business of prospecting, exploration and mining activities for diamonds and other minerals as also in the business of providing consultancy in the field of diamond prospecting and other related matters. The assessee filed a return of income declaring a loss of Rs.4,39,48,222. The AO noticed that the assessee has incurred expenditure of Rs.23,64,44,196 mainly on prospecting for minerals in India, commercial production of minerals has not commenced, the assessee has only capitalised Rs.17,04,80,638. He asked the assessee to show cause why the entire expenses should not be treated as capital expenses u/s.35E and be disallowed. The assessee submitted that apart from the expenses capitalised by the assessee, the assessee has suo moto disallowed Rs.1,20,06,438 and to this extent capitalisation of entire expenses will result in double disallowance. It was also submitted that expenses not capitalised are eligible for deduction u/s.37 and include expenses like property expenses, communication expenses, printing and stationery, travelling and conveyance, membership and subscriptions, etc., which expenses are not incurred wholly and exclusively for the purposes of prospecting. Further, the assessee has also carried consultancy business from which there were receipts of Rs.98,42,810 which receipts have been offered for taxation.
The AO was of the view that any expenditure incurred for the purpose of prospecting eligible minerals is to be capitalised u/s.35E and deduction is to be claimed only when commercial production starts. As regards earning of professional receipts he observed that “even applying the matching concept, it is not possible to accept that there can be expenditure of Rs.5,39,57,120 to earn consultancy income of Rs.98,42,810”. He allowed an ad hoc deduction of 30% for earning the income of Rs.98,42,810. The balance expenditure of Rs.5,10,04,277 was disallowed and treated as capital expenditure eligible for amortisation u/s.35E.
Aggrieved the assessee preferred an appeal to the CIT(A) who, on the basis of what he perceived as applicability of matching concept, restricted the deductibility of expenses and upheld the order passed by the AO.
Aggrieved, the assessee filed an appeal to the Tribunal.
Held:
The Tribunal upon going through the provisions of section 35E and also the CBDT Circular No. 56, dated 19th March, 1971 held that in order to be eligible for amortisation of expenses u/s.35E, the expenses must have been incurred wholly and exclusively for “exploring, locating or proving deposits of any minerals, and includes such operations which prove to be infructuous or abortive”. The Tribunal observed that the AO has proceeded on the basis that since the assessee is, inter alia, engaged in the business of prospecting minerals, all the expenses incurred by the assessee are to be treated as eligible for amortisation u/s.35E, unless he can demonstrate that the expenses are incurred for earning an income which is taxable in the hands of the assessee. The Tribunal held that this is an incorrect approach. The assessee even when he is engaged in the business of prospecting minerals is eligible for amortisation of such expenses as are eligible u/s.35E(2) r.w.s. 35E(5)(a). All other expenses are eligible for deduction as in the normal course of computation of business income.
As regards the restriction of allowability of expenses based on matching concept, the Tribunal held that the application of ‘matching principle’, based on the quantum of earnings, is wholly devoid of any merits. One cannot invoke the matching principle to restrict the deductibility of a part of expenses as a result of the expenses being too high in proportion to quantum of expenditure; it can at best be invoked to spread over the costs over the entire period in which revenues as a result of those costs are generated, such as in deferred revenue expenditure — but even in such cases the restriction on deductibility of expenses have not been upheld by the Co-ordinate Benches as indeed by the Courts. All that the matching principle states is that in measuring net income for an accounting period, the costs incurred in that period should be matched against the revenue generated in the same period, and that where costs result in a benefit over a period beyond one accounting period, the costs should be reasonably spread over the entire period over which the benefits accrue. As far as the position under the Income-tax Act is concerned, as long as expenses are incurred for the purposes of business, even if it turns out to be wholly unprofitable, the same is to be allowed as deduction in computation of business income. By no stretch of logic, matching principle can restrict the quantum of deduction of expenses by relating the same to the quantum of earnings as a result of incurring these expenses. Once the business has commenced, deduction of expenses in respect of that business cannot be declined on the ground that the earnings from consultancy income do not justify such high expenses. This kind of revenue mismatch, which cannot be a ground of disallowing the expenditure in anyway, is a normal commercial practice in the businesses which have long-term perspectives and larger business interests in their consideration.
The Tribunal held that the AO was in error in capitalising the expenses which were not directly attributable to the prospecting of diamonds, as also restricting the deductibility of expenses to 30% of consultancy revenues received by the assessee.
The appeal filed by the assessee was allowed.
