Investment Based Deduction

Kameswara Rao Challa

Budget 2009 has taken a new initiative by introducing the concept of allowing deduction under income-tax for investment made in a new business ‘based on investment’ and ‘not based on profit earned’. It has inserted section 35AD allowing deduction of in­vestment in specified businesses under the Income-tax Act, 1961. This is in place of allowing for exemption or deduction of profit earned from a new business. This amounts to allowing depreciation upfront. With this new initiative, it seems that the Government has changed its priority from ‘investment for indus-trialization’ to ‘invest-ment made’.

1. In the Budget 2009, the Finance Minister, Mr. Pranab Mukher­jee, proposed a new initiative by introducing the concept of allowing deduction under income-tax for investment made in a new business ‘based on investment’ and ‘not based on profit earned’. Mr. Mukherjee said in his Budget Speech,

Under the present scheme of the Income-tax Act, tax exemptions are largely profit-linked. Such incentives are inherently inefficient and liable to misuse. Therefore, it is proposed to incentivise businesses by providing investment-linked tax exemptions..... Under this method, all capital expenditure, other than expenditure on land, goodwill and financial instruments will be fully allowable as deduction.

Clause No. 13 of the Finance Bill, 2009 proposes to insert sec­tion 35AD in the Income-tax Act, 1961, allowing deduction for investment in specified industries. Here is an attempt to analyse this budget initiative.

2. The proposed scheme is an initiative for deduction of invest­ment in a new business from the income of the assessee. It proposes to give deduction of investment made in a specified business. The proposed section is not part of ‘Chapter III: Incomes Which Do Not Form Part of Total Income’ or ‘Chapter VI-A: Deduction To Be Made In Computing Total Income’. It forms part of ‘Chapter IV: Computation of Total Income’ under ‘Part-D: Profits and Gains of Business or Profession’. Sub-section 3 specifically disallows double deduction under section 35AD and under Chapter VI-A of the Act. The proposed section is a beginning in relegating income based exemptions/deductions into the oblivion.

As per sub-section (1) of the proposed section 35AD:

An assessee shall be allowed a deduction in respect of the whole of any expenditure of capital nature incurred, wholly and exclu­sively, for the purposes of any specified business carried on by him during the previous year in which such expenditure is in­curred by him.

The section proposes to allow capital expenditure incurred for specified activities as business expenditure.

As per sub-section (4) of section 35AD:

No deduction in respect of the expenditure referred to in sub-section (1) shall be allowed to the assessee under any other section.

On allowing deduction under section 35AD, the assessee will not be able to claim depreciation under section 32 of the Act. This is also evident from the fact that Explanation 13 is being inserted under section 43(1), whereby the concept of block of assets is by-passed in respect of assets for which deduction is allowed under section 35AD. As per this Explanation, ‘The actual cost of any capital asset on which deduction has been allowed or is allowable to the assessee under section 35AD, shall be treated as ‘nil’. Thus, the new section proposes to allow depreciation upfront, instead of spreading it over various years. This is identical of allowing deduction of capital expenditure for Scien­tific Research under sub-section (1)(iv) read with sub-section (2) of section 35 of the Act.

3. For the present, the deduction under section 35AD is limited to the following three specified activities as per sub-section 8(c) :

(i) setting up and operating a cold chain facility.

(ii) setting up and operating a warehousing facility for storage of agricultural produce.

(iii) laying and operating a cross-country natural gas or crude or petroleum oil pipe line network for distribution, including storage facilities being an integral part of such network."

The above specified activities are for capital incentive indus­tries and for development of infrastructure facilities.

It is interesting to note that the business of laying pipelines for petroleum and natural gas is covered not only under the proposed section 35AD, but also under section 80-IA of the Act. However, deduction is not available under both the sections. Hence, double deduction is not available in respect of the same activity under both the sections.

The deduction is available for an assessee commencing operations with effect from April 1, 2009. However, in respect of an asses­see carrying on the business of laying pipelines for petroleum and natural gas, deduction is available with retrospective ef­fect, even if the business is commenced on or after April 1, 2007.

4. Interestingly, the section lays down the type of persons who are eligible for deduction under the section.

(a) Laying of cross-country pipelines for petroleum products, etc. - Deduction can be claimed only by companies and consortium of companies carrying on the activities. The section is not applicable to other types of persons, i.e., limited li­ability partnership firms, partnership firms, association of persons, Hindu undivided families or individuals. It is true that this activity is mainly carried on by company assessees. For the first time, the Income-tax Act has recognized consortium of companies for the purpose of deduction under the section.

(b) Agricultural warehouse and cold storage facilities - Deduction can be claimed by any person, viz., individual, Hindu undivided family, firm, limited liability partnership, associa­tion of persons, body of individuals or companies. For these activities, consortium of companies is not the recognized assessee.

5. As per sub-section (1), eligible investment is ‘whole of any expenditure of capital nature incurred, wholly and exclusively, for the purpose of any specified business carried on by him during the previous year in which such expenditure is incurred by him.’ Deduction can be claimed in respect of any capital expendi­ture incurred for the specified business. The investment may be in tangible assets and intangible assets. However, as per sub-section 8(f), an assessee cannot claim deduction of certain expenditure even if incurred in respect of the specified activi­ties: ‘any expenditure of capital nature shall not include any expenditure incurred in the acquisition of any land or goodwill or financial instrument’. The section has not defined as to what is capital expenditure. Hence, all the capital expenditures (subject to a small negative list) incurred in respect of a new business are deductible, e.g.:

(a) Tangible Assets - Building, plant & machinery, electri­cal equipment, pollution control equipment, electrical equipment, office equipment, furniture & fixtures, vehicles, computers, etc.

(b) Intangible Assets - Technical know-how, patents, copy right, trade mark, brand value, computer software, etc.

Of all the tangible assets, only ‘land’ is kept out of the purview of deduction. This is perhaps because depreciation is not allowed on land. It is debatable whether cost of land includes land develop­ment. Of the intangible assets ‘goodwill’ is kept out of allowing deduction under the section, whether the goodwill is purchased, acquired, or generated. The section does not allow deduction of ‘expenditure incurred towards financial instruments’. However, the Act has not defined as to what is ‘expenditure for financial instruments’. By usual business parlance, it is cost incurred towards issue of deben­tures, bonds, etc.

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