VODAFONE MOBILE SERVICES LTD. vs DEPUTY COMMISSIONER OF INCOME TAX

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* IN THE HIGH COURT OF DELHI AT NEW DELHI
% Judgment reserved on: March 04, 2025
Judgment pronounced on: March 11, 2025

+ ITA 660/2018
VODAFONE MOBILE SERVICES LTD. …..Appellant
Through: Mr. Sachit Jolly, Sr. Adv. with Ms. Soumya Singh, Ms. Disha Jham and Mr. Abhyudaya Shankar Bajpai, Advs.
versus

DEPUTY COMMISSIONER OF INCOME
TAX …..Respondent
Through: Mr. Indruj Singh Rai, SSC with Mr. Sanjeev Menon, Mr. Rahul Singh, JSCs with Mr. Anmol Jagg, Mr. Gaurav Kumar and Ms. Varsha Sharma, Advs.
CORAM:
HON’BLE MR. JUSTICE YASHWANT VARMA
HON’BLE MR. JUSTICE HARISH VAIDYANATHAN SHANKAR
J U D G M E N T

YASHWANT VARMA, J.

1. The assessee as well as the Revenue seek to assail the correctness of the judgment dated 14 March 2018 rendered by the Income Tax Appellate Tribunal1 and in terms of which the two cross appeals of parties have come to be decided. We had in terms of our order of 23 January 2024 admitted these two appeals on the following questions of law:
“ITA No. 660/2018
A. Whether on the facts and in the circumstances of the case and in law, the ITAT erred in upholding the disallowance of depreciation to the tune of Rs.5,10,79,752/- claimed on account of Asset Reconstruction Cost [“ARC’] being an ascertained liability, or alternatively allowing deduction for such expenditure in the year of execution of lease agreements or over the period of the lease?
B. Whether on the facts and in the circumstances of the case and in law, the ITAT erred in holding that installation of cell site towers amounted to ‘extension of existing business’ as stipulated in proviso to Section 36(1)(iii) of the Income Tax Act, 1961 [“Act”] and, thereby warranting proportionate disallowance of interest under that provision?
C. Whether on the facts and in the circumstances of the case and in law, the ITAT erred in misbranding the discount offered by the Appellant to the pre-paid sim-card distributors as commission and hence upholding disallowance made by the AO under Section 40(a)(ia) of the Act?
ITA 634/2019
A. Whether the ITAT erred in law and on facts in deleting the disallowance amounting to Rs. 14,23,29,976/- on account of commission paid to distributors by ignoring the factual matrix of the case and solely relying upon the decision of the DRP, Ahmedabad wherein the claim on commission expenditure was upheld?
B. Whether the ITAT erred in law and on facts in deleting the disallowance of penalty paid to Department of Telecommunications even though penalty expenses, being penal in nature are not allowable u/s 37 of the Act?”

2. Subsequently and when the appeals were taken up for review on 03 April 2024, we had taken note of the contention of Mr. Jolly, learned senior counsel appearing for the assessee, that the Tribunal had undisputedly failed to deal with the alternative plea which was taken by the assessee with respect to Asset Reconstruction Cost2. The ARC was sought to be factored in while computing depreciation claimed and the same, according to the assessee, being otherwise liable to be accorded recognition by virtue of Section 37(1) of the Income Tax Act, 19613 in case its stand of the same being covered by Section 32 were to not find favour. It was thus contended that the Tribunal had clearly committed a manifest illegality in failing to deal with the aforesaid question.
3. Turning then to the issues emanating from Section 36(1)(iii), we had taken note of the submissions addressed by learned counsels appearing for respective sides and who had extensively argued on the meaning liable to be ascribed to the word ‘extension’ as appearing in the Proviso thereto. Insofar as Question ‘C’ as framed in the assessee’s appeal was concerned, it was conceded that the issue stands conclusively answered and laid to rest in light of the judgment rendered by the Supreme Court in Bharti Cellular Ltd. (now Bharti Airtel Ltd.) vs. Assistant Commissioner of Income Tax & Anr4.
4. The appeals themselves pertain to Assessment Year 2009-10 and arise in the backdrop of the following facts. The assessee which is a company engaged in providing telecommunication services, had filed a Return of Income on 30 September 2009 declaring NIL income after claiming deductions under Section 80IA and having reported profits as per Section 115JB. The return was thereafter revised on 30 March 2011. We are now left to consider the upward transfer pricing adjustments made by the Transfer Pricing Officer5 and which, in these appeals stand confined to the question of depreciation under Section 32 or alternatively under Section 37 and the interest burden on borrowed capital founded on Section 36(1)(iii) of the Act. It is under these heads that the TPO had inter alia made additions apart from others and which, admittedly, do not survive for our consideration.
5. The Draft Assessment Order framed on 28 March 2013 under Section 144C read with Section 143(3) was assailed before the Dispute Resolution Panel6 and which vide its directions dated 18 December 2013 accorded partial relief to the assessee under the head of ad hoc disallowance of commission expenditure. This led to the passing of a final assessment order on 30 January 2014. It is this order which formed the subject matter of the two cross appeals which came to be instituted before the Tribunal.
6. Having noticed the principal questions which arise for our consideration, we deem it appropriate to firstly advert to the issue of disallowance of depreciation under Section 32 of the Act. It becomes relevant to note that the disallowance of depreciation constituted Ground no.2 of the assessee’s appeal. The depreciation itself was claimed in respect of fixed assets and the ARC that was provisioned for on account of the same being likely to be incurred in purported discharge of an obligation which stood placed upon the assessee to restore the cell sites to their original condition.
7. The assessee appears to have urged that it had capitalized certain sums on account of the ARC obligation, and which represented the estimated cost likely to be incurred at the network sites and office premises in order to restore them to their original condition at the end of the lease period. The appellant had claimed depreciation in this respect in the sum of INR 5.10 crores. The provision itself was made in light of Accounting Standard 297 on the basis of the same constituting a present obligation and which could be reasonably estimated. However, the AO proceeded to disallow the said provision holding that it was not in the nature of an ascertained liability. It also rejected the alternate plea of the assessee resting on Section 37 of the Act. The objections which were taken in this respect came to be rejected by the DRP and the view so expressed affirmed ultimately by the Tribunal.
8. The Tribunal records that the appellant had estimated the aforenoted sum as likely to be incurred in the course of restoration of the said sites and which was an obligation which already stood placed upon it. However, it took the view that the word “actual cost” as it appears in Section 32 would have to derive meaning from Section 43(1) of the Act and thus constitute actual cost of assets to the assessee reduced by that portion of the cost as may have been directly or indirectly made. It thus came to conclude that depreciation could have been claimed only if a cost had in fact been incurred. This becomes evident from a reading of Para 17 of the order impugned before us and which is reproduced hereinbelow: –
“17. Having heard both the sides and perused the relevant material on record, we find that the assessee entered into lease agreement with owners of various office spaces for setting up of cell site towers. As per the assessee, it was obliged to restore the site to its original condition at the expiry of the lease period. The assessee estimated a sum to be incurred on restoration and capitalized the same to the cost of cell site towers at the very threshold of entering into lease agreements. Not only this, the assessee also claimed depreciation on such estimated restoration cost capitalized. It is clear from the facts that no such cost was actually incurred by the assessee and a sum was notionally estimated and capitalized for the purpose of depreciation. Section 32(1) provides for depreciation on the actual cost’ of block of assets in the first year and, then, on the written down value as prescribed in the provision. Section 43(1) defines ‘actual cost’ to mean the actual cost of assets to the assessee reduced by that portion of the cost thereof, if any, as has been directly or indirectly made by any other person or authority. On a conjoint reading of the above provisions it is manifest that depreciation can be claimed only on the actual cost of assest ‘which is incurred by the assessee.’ There is no question of providing depreciation on a notional cost which at the most can be considered as an unascertained liability. Under these circumstances, we are of the considered opinion that the authorities below were fully justified in rejecting the assessee’s claim of depreciation of Rs. 5 .10 crore on the so-called asset restoration cost obligation.”
9. The Tribunal also construed the relevant provisions of the lease agreement and especially the words “if any damage is caused” as being demonstrative of no positive obligation being placed upon the appellant. This becomes evident from a reading of Para 18 and which reads thus: –
“18. In support of the assessee’s claim that it incurred an obligation for restoration of site, a copy of an agreement dated 01.10.2010 entered into between the assessee and Upal Developers Pvt. Ltd., was placed on record which provides for monthly rent of Rs. 5,000/- and the further sum of Rs. 5000/- per month towards ‘maintenance charges’. Consequences of determination of the agreement have been set out in clause 10, which is the bedrock of the assessee’s claim for the asset restoration cost obligation and resultant depreciation. The relevant part of this clause provides that the assessee; “shall at its own cost restore the premises of the said building to its original state, if any damage is caused in the court of the removal of cables, antennas or other equipments.” There is absolutely no doubt on the interpretation of clause 10 of the agreement that the assessee will be obliged to incur cost at the time of determination of the agreement only if damage is caused in the course of removal of cables, antennas or other equipments and not otherwise. Damage to the premises, if any, arising on the removal of cables, antennas and other equipments, etc., can be ascertained only at the time of termination of the agreement and not at the time of entering into the agreement. Further, no obligation will be incurred if no loss is caused to the premises at the time of removal of cables etc. as such, we are of the considered opinion that the addition of Rs. 5.10 crore has been rightly made. This ground is not allowed”

10. Insofar as the question of the provision made by the assessee on account of ARC and whether it would be exigible to deduction under Section 32, the dispute revolves upon the usage of the expression ‘actual costs’ appearing in Section 32(1)(ii) sub-clause (i). It was in the aforesaid context that Mr. Jolly had sought to draw sustenance from the provisions comprised in Section 43 and which provides that the word ‘actual cost’ as appearing in Sections 28 to 41 of the Act, unless the context otherwise require, would mean the actual cost of the assets to the assessee. It is in the aforesaid context that Mr. Jolly had submitted that Section 32, as well as the expression ‘actual cost’ would not be confined to expenditure in fact incurred, but would include appropriate provisions which may be made in respect of obligations incurred. It was his submission that the provisions which the assesee had made were in accord with AS 29 and which makes provisions with respect to ‘liabilities’, ‘obligating events’ and guides assessee’s with respect to the incorporation of a provision in the books provided the conditions specified in Clauses 14, 16 and 24 are broadly met.
11. As was noticed by us in our previous orders, it was Mr. Jolly’s submission that quite apart from the claim of depreciation which was founded on Section 32, the appellants had also taken an alternate plea of the expenditure so provisioned for being liable to be claimed as a deduction referable to Section 37 of the Act. Section 37, insofar as it is relevant for our purposes is extracted hereunder: –
“37. General. 
(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 [***] and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
[Explanation 1.]—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.]
[Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.]
[Explanation 3.—For the removal of doubts, it is hereby clarified that the expression “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” under Explanation 1,shall include and shall be deemed to have always included the expenditure incurred by an assessee,—
(i) for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India; or
(ii) to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person; or
(iii) to compound an offence under any law for the time being in force, in India or [outside India]”

12. Mr. Jolly thus submitted that ARC would constitute expenditure ‘….laid out or expended…’ for the purposes of business and thus liable to be factored in while computing income chargeable under the head of profits and gains of business or profession. It was Mr. Jolly’s submission that Section 43 significantly uses the expression actual cost of the assets ‘to the assessee’ and thus clearly not contemplating costs having been incurred in praesenti or on the date of preparation of the Balance Sheet. It was submitted that the Madras High Court in M/S Vedanta Limited vs. The Joint Commissioner of Income Tax8 had, on a due review of the various precedents rendered in the context of a provision being made as well as the Accounting Standards which apply had come to explain the meaning to be ascribed to the phrase ‘….laid out or expended..’ in the following terms:-
“20. The words “Lay (Laid out)” or “Expend (Expended)”, as employed in Section 37(1) of the Act, are defined in the following manner, in the Second Edition of the Oxford English Dictionary published by Clarendon Press-Oxford, in the following manner:
“Expend- to pay out, spend. It differs from spend in being less colloquial, and (in mod.use) in implying some determinate direction or object of outlay.

(a) To put away, lay out, spend (money). To spend, make away with, consume in outlay.
(b) To lay out (money) for determinate objects. Const.in, upon.
Expendable- Also expendible- That may be expended; considered as not worth preserving or salvaging; normally consumed in use; spec. of military personnel; that may be allowed to be sacrificed to achieve a military objective. hence as sb., an expendable person or object.
Lay-To put away in store; to store up; to save (money).
– To put away for future disposal or for safety.
– To spend, expend, lay out.

21. These definitions indicate that the words Lay, Laid or Expend do not merely include the immediate expenditure or laying out of the funds, but if they are set apart for a determinate and the specific object also, a future actual expenditure is also included in these terms.”

13. It was in the aforesaid context that Mr. Jolly had also adverted to the various prescriptions comprised in AS 29 and which regulate the creation of a provision in Balance Sheets. For purposes of evaluating the aforenoted submission, we deem it apposite to extract the following relevant parts of AS 29:-
“Accounting Standard (AS) 29
Provisions, Contingent Liabilities and Contingent Assets
(This Accounting Standard includes paragraphs paragraphs set in bold italic type and plain type, which have equal authority. Paragraphs set in bold italic type indicate the main principles. This Accounting Standard should be read in the context of its objective and the General Instructions contained in part A of the Annexure to the Notification.)
Pursuant to this Accounting Standard coming into effect, all paragraphs of Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date, that deal with contingencies (viz., paragraphs 1 (a), 2, 3.1, 4 (4.1 to 4.4), 5 (5.1 to 5.6), 6, 7 (7.1 to 7.3), 9.1 (relevant portion), 9.2, 10, 11, 12 and 16), stand withdrawn except to the extent they deal with impairment of assets not covered by other Indian Accounting Standards.

Objective
The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The objective of this Standard is also to lay down appropriate accounting for contingent assets.
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7. This Standard defines provisions as liabilities which can be measured only by using a substantial degree of estimation. The term ‘provision’ is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Standard.
8. Other Accounting Standards specify whether expenditures are treated as assets or as expenses. These issues are not addressed in this Standard. Accordingly, this Standard neither prohibits nor requires capitalisation of the costs recognised when a provision is made.
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Definitions
10. The following terms are used in this Standard with the meanings specified:
10.1 A provision is a liability which can be measured only by using a substantial degree of estimation.
10.2 A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
10.3 An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.
10.4 A contingent liability is:
(a) a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.
10.5 A contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise.
10.7 Possible obligation – an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable.
10.8 A restructuring is a programme that is planned and controlled by management, and materially changes either:
(a) the scope of a business undertaken by an enterprise; or
(b) the manner in which that business is conducted.

11. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. Obligations also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.
12. Provisions can be distinguished from other liabilities such as trade payables and accruals because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement. By contrast:
(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and
(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees. Although it is sometimes necessary to estimate the amount of accruals, the degree of estimation is generally much less than that for provisions.
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Recognition
Provisions
14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised.

Present Obligation

15. In almost all cases it will be clear whether a past event has given rise to a present obligation. In rare cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation. In such a case, an enterprise determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the balance sheet date. On the basis of such evidence:
(a) where it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognises a provision (if the recognition criteria are met); and
(b) where it is more likely that no present obligation exists at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).

Past Event

16. A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.

17. Financial statements deal with the financial position of an enterprise at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date.

18. It is only those obligations arising from past events existing independently of an enterprise’s future actions (i.e. the future conduct of its business) that are recognised as provisions. Examples of such obligations are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the enterprise. Similarly, an enterprise recognises a provision for the decommissioning costs of an oil installation to the extent that the enterprise is obliged to rectify damage already caused. In contrast, because of commercial pressures or legal requirements, an enterprise may intend or need to carry out expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory). Because the enterprise can avoid the future expenditure by its future actions, for example by changing its method of operation, it has no present obligation for that future expenditure and no provision is recognised.
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Probable Outflow of Resources Embodying Economic Benefits
22. For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation. For the purpose of this Standard, an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not. Where it is not probable that a present obligation exists, an enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).
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Reliable Estimate of the Obligation
24. The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature involve a greater degree of estimation than most other items. Except in extremely rare cases, an enterprise will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is reliable to use in recognising a provision.
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Contingent Liabilities
26. An enterprise should not recognise a contingent liability.
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28. Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability. The enterprise recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made (see paragraph 14).
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Illustration A
Tables – Provisions, Contingent Liabilities and Reimbursements
The purpose of this illustration is to summarise the main requirements of the Accounting Standard. It does not form part of the Accounting Standard and should be read in the context of the full text of the Accounting Standard.
Provisions and Contingent Liabilities
Where, as a result of past events, there may be an outflow of resources embodying future economic benefits in settlement of: (a) a present obligation the one whose existence at the balance sheet date is considered probable; or (b) a possible obligation the existence of which at the balance sheet date is considered not probable.
There is a present obligation that probably requires an outflow of resources and a reliable estimate can be made of the amount of obligation.
There is a possible obligation or a present obligation that may, but probably will not require an outflow of resources.
There is a possible obligation or a present obligation where the likelihood of an outflow of resources is remote
A provision is recognised (paragraph 14).
Disclosures are required for the provision (paragraphs 66 and 67)
No provision is recognised
(paragraph 26).
Disclosures are required for the contingent liability (paragraph 68).
No provision is recognised (paragraph 26).
No disclosure is required. (paragraph 68).
Reimbursements
Some or all of the expenditure required to settle a provision is expected to be reimbursed by another party

The enterprise has no obligation for the part of the expenditure to be reimbursed by the other party.
The obligation for the amount expected to be reimbursed remains with the enterprise and it is virtually certain that reimbursement will be received if the enterprise settles the provision.
The obligation for the amount expected to be reimbursed remains with the enterprise and the reimbursement is not virtually certain if the enterprise settles the provision.
The enterprise has no liability for the amount to be reimbursed (paragraph 50).
The reimbursement is recognised as a separate asset in the balance sheet and may be offset against the expense in the statement of profit and loss. The amount recognised for the expected reimbursement does not exceed the liability (paragraphs 46 and 47).
The expected reimbursement is not recognised as an asset (paragraph 46).
No disclosure is required.
The reimbursement is disclosed together with the amount recognised for the reimbursement (paragraph 67(c)).
The expected reimbursement is disclosed (paragraph 67(c)).”
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Illustration 3: Offshore Oil field
An enterprise operates an offshore oil field where its licensing agreement requires it to remove the oil rig at the end of production and restore the seabed. Ninety per cent of the eventual costs relate to the removal of the oil rig and restoration of damage caused by building it, and ten per cent arise through the extraction of oil. At the balance sheet date, the rig has been constructed but no oil has been extracted.
Present obligation as a result of a past obligating event -The construction of the oil rig creates an obligation under the terms of the licence to remove the rig and restore the seabed and is thus an obligating event. At the balance sheet date, however, there is no obligation to rectify the damage that will be caused by extraction of the oil.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion -A provision is recognised for the best estimate of ninety per cent of the eventual costs that relate to the removal of the oil rig and restoration of damage caused by building it (see paragraph 14). These costs are included as part of the cost of the oil rig. The ten per cent of costs that arise through the extraction of oil are recognised as a liability when the oil is extracted.”

14. Reverting then to the judgment in Vedanta Limited, Mr. Jolly invited our attention to the following passages of that decision: –
“29. Thus on the conspectus of the legal precedents discussed above, we are of the clear opinion that for the three Assessment Year in question, the provision made by the Assessee for ‘Site Restoration cost’ under the contractual obligations of the Assessee in the Product Sharing Contract, made on scientific basis was clearly an allowable expenditure in question should be laid out or expended wholly for the purpose of business of the Assessee. There is no dispute that the Provision on question was made wholly and exclusively for the purpose of business. The only dispute was that expenditure not actually incurred in there years and the amount was to be spent in future out of the Provision made during these Assessment years namely A.Y.1996-1997 to 1998-1999.
30. We find no prohibition or negation for making a provision for meeting such a future obligation and such a provision being treated as a revenue expenditure under Section 37(1) of the Act. The Hon’ble Supreme Court in the case of Calcutta Company Limited clearly held that the words Lay (laid out) or Expend includes expendable in future also, which has been quoted by us above. The making of a Provision by an Assessee is a matter of good business or commercial prudence and it is to set apart a fund computed on scientific basis to meet the expenditure to be incurred in future. There is no time frame or limitation prescribed for the said provisions to be actually spent. Merely because in the context like the one involved in this case, the contract period was long viz., 25 years, which too now stands extended by period of ten years or more and therefore the actual work of site restoration may happen after 35 years depending upon the actual exploration of oil reserves and the Site restoration would be undertaken only if there is no longer some oil to be explored or drawn out and, therefore, it cannot be said that the provision made for the three Assessment Years presently at the beginning of the Contract period was irrational or an disallowable expenditure. The question of commercial expediency is a usual business and the economic decision to be taken by the Assessee and not by the Revenue Authorities and therefore the provision made on a reasonable bias, cannot be disallowed under section 37(1) of the Act, unless it can be said to be have no connection with the business of the Assessee. The words wholly and exclusively for the purpose of business is a sufficient safeguard and check and balance by the Revenue Authorities to test and verify the creation of provision for meeting a liability by the Assessee in future and its connectivity with the business of the Assessee. Assuming that such set apart provision is not actually spent in future, or something less is spent of Site Restoration, nothing prevents Revenue Authorities and Assessee himself to offer it back for taxation in such future year, the unspent Provision to be brought back to tax as per Section 41(1) of the Act.”

It was in the aforesaid backdrop that learned senior counsel submitted that the Tribunal had committed a manifest error in failing to deal with this significant issue which was directly raised for its consideration.
15. Upon hearing learned counsels for respective sides, we deem it apposite to observe at the very outset that we do not propose to deal with the issue pertaining to ‘actual cost’ as it appears in Section 32(1) since, upon a holistic examination of the rival submissions which were addressed, we for reasons which we propose to assign hereinafter would be of the opinion that it is the alternate plea based on Section 37 which alone would merit further consideration. This more so in light of the stand of the assessee as voiced by Mr. Jolly that they would be content if the Court were to answer that issue alone especially since the same would be more advantageous. As is manifest from a reading of Section 37, any expenditure, provided it is not capital in character, when laid out or expended wholly and exclusively for the purposes of business, is liable to be taken into consideration while computing income chargeable under the head profits and gains of business or profession. This provision thus focuses on expenditure ‘laid out’ or ‘expended’ as opposed to the identification of an actual cost and which constitutes the heart of Section 32.
16. This would constitute an appropriate juncture to also broadly capture the issues which emanate from Section 36(1)(iii) of the Act and the challenge which stood raised by the appellant assessee to the disallowance of interest paid in respect of capital borrowed for purposes of business. Insofar as this aspect is concerned, the Tribunal had taken note of the admitted fact of the appellant having declared Capital Work-in-Progress9 amounting to INR 278.96 million in its Balance Sheet. The Tribunal records that the AO, however, had found that the above was in addition to Fixed Assets disclosed to be INR 12828 million as an item distinct from CWIP which was shown separately. It has then proceeded to hold that since CWIP would not qualify the requirement of “extension of existing business”, as that phrase existed in the Proviso to Section 36(1)(iii) at the relevant time, the interest was liable to be disallowed. It becomes pertinent to note that the expression “extension of existing business” as it stood in the Proviso to Section 36(1)(iii) ultimately come to be deleted by Finance Act, 2015 with effect from 01 April 2016. However, and since in the present appeal we are concerned with AY 2009-10, we would have to proceed on the basis of the Proviso existing and governing the applicability of Section 36(1)(iii) of the Act.
17. Insofar as the creation of assets is concerned, the Tribunal had taken note of the contention of the appellant in the following terms: –
“21. After considering the rival submissions and perusing the relevant material on record, it is first necessary to understand the nature of the capital work-in-progress capitalised in the balance sheet at Rs.2789 million. On a pertinent query, the Id. A.R submitted that this amount represents the cost of installing new cell site towers to be used for providing a better network to its customers. It was stated that roughly a period of three months is spent in the setting up of a tower. During the currency of such period of three months, i.e., when a tower is being set up, the costs incurred on such installation of towers are booked under the head ‘Capital work-in-progress’. When installation gets completed, the amount so capitalised is transferred from the ‘capital work-in-progress’ account to the ‘fixed assets’ in regular course. From the above narration of factual background, it is clear that a sum of Rs.2789.6 million represents the amounts incurred by the assessee up to the end of the year on installation of towers, whose process of installation was still on at the end of the year. In other words, this figure represents the value of assets which may still not been used by the assessee during the year for its business purpose. The AO invoked first proviso to section 36(1 )(iii) which, at the material time, read as under:-
‘Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset/or extension of existing business or profession (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.’”
18. It proceeded to negate the contention that the interest burden would qualify the requirement of “extension of existing business” in the following terms: –
“24. We are not convinced with the contention advanced by the Id. AR. The words ‘for extension of the existing business’ presuppose that there is already a business in existence and capital is borrowed for acquisition of assets for extension of such existing business. ‘Extension’ can be vertical as well as horizontal. Existing telecommunication business can be extended in different forms. One of such forms can be the one described by the Id. AR in which a Cellular mobile service provider (CMSP) expands its area of business to a different Circle which was not hitherto- in its reach. In the same breath, there can be an extension of existing business when CMSP increases its reach within the allotted Circle itself by means of setting up new towers. To put it simply a CMSP has license to operate in a particular state, it may initially set up cell towers catering to urban areas for meeting the requirements of population residing therein. With the passage of time, it may try to reach to rural areas and still more rural areas within the same State by establishing towers for providing connectivity in such areas as well. With new towers in areas, which were hitherto not having connectivity because of lack of the coverage of adequate existing towers, the service provider will, naturally, be going in ‘for extension of existing business.’ With such a setting up of new towers, the service provider will increase its customer base within the existing Circle, which is nothing but an extension of existing business.
25. When we advert to the facts of the instant case, it emerges that the assessee was successful in increasing its customer base by setting up new towers, cost of which has been classified as capital work-in progress. It is evident from the assessee’s Director’s Report for the year under consideration which records that: “the company has also witnessed a good level of increase in the subscriber base in all the three Circles (UPE, Rajasthan and Haryana) in which it operates. The company has further expanded its network to increase its coverage across all its Circles. During the year the company added 5096 cell sites to enhance its network coverage closing with 14411 cell sites as at 31st March, 2009.” It is evident from the assessee’s Director’s Report that the setting up of new cell sites has enhanced its network coverage within all the three existing Circles and the resultant customer base, which is nothing, but, an extension of existing business. We, therefore, hold that the argument advanced by the Id. AR that the setting up of new cell sites, the cost of which was capitalised in the balance sheet as Capital work in progress (CWIP), does not lead to extension of existing business, is sans merit and, hence, dismissed.”
19. Before we proceed to notice the elaborate submissions which were advanced by Mr. Jolly based on a perceived distinction between the words ‘extension’ and ‘expansion’ as well as how the phrase ‘extension of business’ itself should be understood, we note that the Tribunal had, while ruling on this question, also alluded to certain recitals appearing in the Director’s Report for the year under consideration. It has essentially borne in consideration the following paragraph from the Director’s Report:-
“DIRECTORS’ REPORT

The Directors have pleasure in presenting the Annual Report and Audited Accounts for the year ended on 31st March 2009.

FINANCIAL PERFORMANCE

Set out below is the summary of the financial performance of the Company during the year under review:

The Earning Per Share for the year has substantially declined to Rs. 3.1 per share from Rs. 34.6per share in the previous period which can be attributed primarily due to increased rates in depreciation resulting in higher depreciation and amortisation costs coupled with higher finance and fuel costs.

DIVIDEND
With a view to augment resources, your Directors do not recommend any Dividend.

OPERATIONS
2008-09 was a challenging year for all Telecom Operators. The year witnesses launch of several new operators coupled with regulatory driven tariff cuts, drop in International Inroaming traffic due to global economic slowdown. The end of the year finally saw the impact of the global slowdown hitting India visibly in statistical terms.
During the year under review, the Company has further widened its innovative and user friendly services. Keeping in line with the latest global technology, the company introduced a variety of Value Added Services (“VAS”), and expanded its data business on blackberry & Vodafone Live. The Company has also witnessed a good level of increase in the subscriber base in all the circles in which it operates. The Company, in line with its group’s initiatives launched the “happy to help” customer service initiative and many Value Added Services like Voice mail, election pack, Amar Chitra Katha, full song downloads, portfolio tracker and various ‘Alert’ services which was met with overwhelming response.
The Company has also witnessed a good level of increase in the subscriber base in all the three circles (UPE, Rajasthan and Haryana) in which it operates. The Company has further expanded its network to increase its coverage across all its circles. During the year the Company added 5096 cell sites to enhance its network coverage, closing with 14,411 cell sites as at 31 March 2009. The Company has outsourced some of its major functions i.e IT, Cell Site passive infrastructure maintenance to IBM and Indus respectively during the year, which will bring cost efficiencies in the coming years.”

20. Mr. Jolly submitted that if the finding of the Tribunal which flows from a perceived reading of the extracts appearing in the Director’s Report were to be accepted, the appellant would clearly not fall within the mischief of the Proviso since those extracts had spoken of a network already established and put to use. It was in the aforesaid context that Mr. Jolly submitted that the ultimate conclusions rendered by the Tribunal are clearly contradictory and the order impugned before us is thus liable to be set aside on this score alone.
21. An ancillary issue which appears to have arisen was whether the investment in CWIP was made out of interest free funds available with the appellant itself and thus not entirely on the basis of capital borrowed for the purposes of making such an investment. This issue came to be answered by the Tribunal as under: –
“27. Before dealing with this contention it is worthwhile to mention that the assessee made investment of Rs. 2789.6 Million in its CWIP, which is the centre of dispute. On having a glimpse at the balance sheet of the assessee, it becomes evident that it has paid up Share capital to the tune of Rs.1011.0 Million and Reserves and Surplus for a sum of Rs.4571.8 Million. Thus, it is palpable that as against the investment of Rs. 2789.6 Million in CWIP, the assessee has its own shareholders fund for a sum of Rs. 5582.9 Million, which is roughly double the amount of Capital work in progress.
28. Section 36(1 )(iii) provides for deduction of interest of the amount of interest paid in respect of capital borrowed for the purpose of business or profession. The essence of this provision is that the interest should be allowed so long as the capital borrowed, on which such interest is paid, is used for the purpose of business or profession. If, however, an assessee is having its own interest free surplus funds and such funds are utilised as interest free advances even for a non business purpose, there cannot be any disallowance of interest paid on interest bearing loans. The Hon’ble Bombay High Court in CIT vs. Reliance Utilities and Power Ltd. (2009) 313 ITR 340 (Bom), has held that where an assessee possessed sufficient interest free funds of its own which were generated in the course of relevant financial year, apart from substantial shareholder’s funds, presumption stands established that the investments in sister concerns were made by the assessee out of interest free funds and, therefore, no part of interest on borrowings can be disallowed on the basis that the investments were made out of interest bearing funds. In that case, the AO recorded a finding that a sum of Rs.213 crore was invested by the assessee out of its own funds and Rs. 1.74 crore out of borrowed funds. Accordingly, disallowance of interest was made to the tune of Rs.2.40 crore. The assessee argued that no part of interest bearing funds had gone into investment in those two companies in respect of which the AO made disallowance of interest. It was also argued that income from operations of the company was Rs.418.04 crore and the assessee had also raised capital of Rs. 7 .90 crore, apart from receiving interest free deposit of Rs.10.03 crore. The assessee submitted before the first appellate authority that the balance-sheet of the assessee adequately depicted that there were enough interest free funds at its disposal for making investment. The ld. CIT(A) got convinced with the assessee’s submissions and deleted the addition. Before the Tribunal, it was contended on behalf of the revenue that the shareholder’s fund was utilized for the purchase of its assets and hence the assessee was left with no reserve or own funds for making investment in the sister concern. Thus, it was argued that the borrowed funds had been utilized for the purpose of making investment in the sister concern and the disallowance of interest was rightly called for. The Tribunal, on appreciation of facts, recorded a finding that the assessee had sufficient (funds of its own for making investment without using the interest bearing funds. Accordingly, the order of CIT(A) was upheld. When the matter came up before the Hon’ble High Court, it was contended by the Department that the shareholders’ funds stood utilized in the purchase of fixed assets and hence could not be construed as available for investment in sister concern. Repelling this contention, the Hon’ble High Court observed that : “In our opinion, the very basis on which the Revenue had sought to contend or argue their case that the shareholders’ fund to the tune of over Rs.172 crore was utilized for the purpose of fixed assets in terms of the balance- sheet as on March 31, 1999, is fallacious.” In upholding the order of the Tribunal, the Hon’ble High Court held that, “if there be interest free funds available to an assessee sufficient to meet its investment and at the same time the assessee had raised a loan, it can be presumed that the investments were from the interest free funds available”. Thereafter, the judgment of the Hon’ble Supreme Court in the case of East India Pharmaceutical Works Ltd. Vs. CIT (1997) 224 ITR 627 (SC) and also the judgment of the Hon’ble Calcutta High Court in Woolcombers of India Ltd. Vs. CIT (1981) 134 ITR 219 (Cal) were considered. It was finally concluded that “The principle, therefore, would be that if there are funds available both interest free and overdraft and/or loans taken, then a presumption would arise that the investments would be out of interest free funds generated or available with the company, if the interest free funds were sufficient to meet the investment”. Consequently the interest was held to be deductible in full.
29. From the above judgment, it is manifest that there can be no presumption that the shareholders’ fund of a company was utilized for purchase of fixed assets. If an assessee has interest free funds as well as interest bearing funds at its disposal, then the presumption would be that investment were made from interest free funds at its disposal. Similar view has been taken by the Hon’ble Delhi High Court in CIT vs. Tin Box Company (2003) 260 JTR 637 (Del), holding that when the capital and interest free unsecured loan with the assessee far exceeded the interest free loan advanced to the sister concern, disallowance of part of interest out of total interest paid by the assessee to the bank was not justified.
30. The legal position set out in the preceding para is applicable if an assessee has a common pool of funds and some part is investment in the disputed amount. This proposition does not hold water, if a specific borrowing is made for making such an investment. When we turn to the facts of the instant case, we find that even though the shareholders’ fund is more than the investment in CWIP, but no detail of secured loan is available. In the absence of such specific information, it is difficult to decide the issue at our end. The impugned order is set aside to this extent and the AO is directed to decide this issue afresh in consonance with our foregoing observations. It is made clear that if there is some direct borrowing for investing in CWIP, then interest paid on such borrowing has to be disallowed. If, on the other hand there is no specific borrowing, the financing of CWIP has to be treated as out of interest- free shareholder’s fund. In such a scenario, no disallowance of interest can be made as the interest-free shareholders’ fund would be higher than the amount of investment in CWIP.”

The Tribunal has thus, and as is evident from the above, ultimately left it open for the AO to examine the extent to which borrowings may have been utilized in connection with CWIP and the interest free funds that may have been used in the course thereof.
22. We propose to take up the issues pertaining to the question of depreciation and of whether a provision could have been made by the assessee insofar as ARC was concerned. From a reading of the order of the Tribunal we note that an amount of INR 510,79,752 had come to be disallowed by the AO and which was claimed as being part of the cost likely to be incurred on account of ARC. The stand of the assessee in this respect came to be rejected with the AO taking the position that the provision made was not in the nature of an ascertained liability and which was also affirmed by the Tribunal. It is this stand which was reiterated by Mr. Rai and who had principally argued that ARC was clearly a contingent liability as explained by AS-29 and, therefore, no provision could have been made in respect thereof.
23. According to Mr. Rai, the Lease Agreement itself had used the expression ‘if any’ and thus clearly being indicative of there being no present obligation that could be acknowledged in law. Mr. Rai had in this respect also sought to draw sustenance from a judgment rendered by a Division Bench of the Court in Seagram Distilleries Pvt. Ltd. (Now Pernod Ricard India Pvt. Ltd.) v. Commissioner of Income Tax10 and where the Court had an occasion to review some of the provisions comprised in AS-29. It, however, becomes pertinent to note that Seagram Distilleries arose in the context of a provision which the assessee had made in respect of transit breakages. The Court was thus called upon to consider whether breakage of bottles during transit and a provision made in respect thereof was liable to be viewed as a liability and whether it could be said to have been estimated on a scientific basis. While dealing with that question and on a review of the various provisions contained in AS-29, the Court held as follows: –
“11. AS 29 further states that ‘provisions’ are distinguishable from other liabilities such as trade payables and accruals “because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement.” However a ‘provision’ is recognised only where:
“(a) an enterprise has a present obligation as a result of a past event:
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
12. If these conditions are not met, no provision should be recognised.”
13. Appendix A to AS-29 sets out in a tabular the summary of the AS. The provisions which are recognised and those that are not are set out in separate columns. What is not recognised is a provision for a liability which arises from ‘a possible obligation’ that may, but probably will not, require an outflow of resources.
14. It is not in dispute that as and when transit breakages do occur the resultant losses are allowable as revenue expenditure, given the nature of the business of the Assessees. The decision in Commissioner of Income Tax v. Balaji Distilleries Ltd. (supra) and Commissioner of Income Tax v. Brindavan Beverages (P) Ltd. (supra) recognised this. In fact, for AYs 2002-03 to 2004-05 the AO has allowed transit breakages as revenue expenditure in the year in which the breakages occurred.
15. The issue, however, is the justification for creating a provision for such breakages anticipating them in advance of the occurrence of the actual breakages. If such transit breakages cannot be estimated with a reasonable degree of certainty then the liability on that score would be considered ‘contingent’ in terms of the definition of that expression in AS 29 i.e. “a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise”. AS 29 itself makes it explicit that no provision for a contingent liability would be recognised.
16. As regards the judicial decisions on the point, the Court proposes to first discuss the decision in Bharat Earth Movers (supra). There the Assessee had floated a beneficial scheme for its employees for encashment of leaves. The Assessee made a provision for meeting the liability to the extent of the entitlement of the officers and staff to accumulated earned leaves in terms of the scheme and claimed that provision as a deduction. The ITAT held in favour of the Assessee but the High Court reversed it on the ground that the provision for the accrued leaves was a contingent liability. The Supreme Court, however, disagreed with the High Court and held as under:
“The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied, the liability is not a contingent one. The liability is in prasenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.”
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18. On facts, in Bharat Earth Movers (supra), the Supreme Court was satisfied that the provision made by the Assessee for meeting the liability “incurred by it under leave encashment scheme proportionate with the entitlement earned by the employees of the company… is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability” and that “the liability is not a contingent liability.” The decision acknowledged that where a scheme for leave encashment is floated by a company, the number of employees and their entitlements to leave encashment can be estimated with a reasonable degree of certainty. It would be a case of a ‘known’ liability.
19. In Commissioner of Income Tax v. Vinitec Corporation P. Ltd. (supra) the question for consideration was whether a provision for future warranty expenditure is a contingent liability. On facts, it was not in dispute that the warranty clause was part of the sale document and imposed a liability on the Assessee to discharge an obligation under the clause for the period of warranty. “It was a liability which was capable of being construed in definite terms which had arisen in the accounting year even though the actual quantification and discharge was deferred to a future date.” In terms of the accepted principles of commercial practice and accountancy, it was held that a liability accrued, though discharged at a future date would be a proper deduction.”
24. After having examined some of the decisions pertinent to the question which stood posed, the Court ultimately negated the stand of the assessee upon forming the opinion that no uniform or scientific method could be discerned so as to justify the creation of a provision. This becomes evident from a reading of Paras 24 and 27 of the report and which are extracted hereinbelow: –
“24. The Court is unable to discern any uniform scientific method followed by the Appellant in making provision for the breakages. As noticed by the ITAT in its order dated 16thMarch 2009, the explanation offered by the Appellant was that on an ad hoc basis it fixed a rate per case of bottles. In the case of Andhra Pradesh, the rate was Rs. 10 per case, for Goa and Karnataka it was Rs. 15 per case. Also the breakages are known within a period of 15 to 30 days after despatch of the goods. The Court also concurs with the view of the ITAT that with the first Assessee having entered the line of business only from AY 2001-02, it cannot be said to have gathered sufficient experience to have reasonably estimated such breakages for the AYs in question. In the circumstances, the ‘liability’ on that score could at best be described as a ‘contingent liability’ as defined in AS-29
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27. To summarise the legal position as far as the Assessees are concerned:
(a) There is no reasonable scientific method adopted by the Assessees to estimate the transit breakages so as to justify creating of provision for such breakages.
(b) The provision would, in the circumstances, be a provision for a contingent liability and, therefore, in terms of the AS 29 ought not be recognised.
(c) The actual transit breakages as and when they occur are allowable as revenue expenditure in the accounting year in which such breakages occur.”
25. Mr. Rai had also cited for our consideration the judgment of the Supreme Court in Rotork Controls India (P) Ltd. v. CIT11. In Rotork, the Supreme Court was called upon to examine whether a provision made with respect to possible warranty claims connected with the sale of goods, could be said to be an actual, accrued or contingent liability. It appears to have been urged by the Revenue in that case that since in the relevant year no claim for replacement had been received, the assessee could not have made any provision in its books of accounts.
26. The Supreme Court in Rotork proceeded to lucidly explain the concept of a provision as understood in accounting practise and the distinction which one must recognise between a positive obligation and a contingent liability. We thus deem it apposite to extract the following passages from that decision: –
“22. What is a provision? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognised when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognised.
23. Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that is recognised as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole.
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25. In the present case, the appellant has been manufacturing and selling valve actuators. They are in the business from Assessment Year 1983-1984 onwards. Valve actuators are sophisticated goods. Over the years the appellant has been manufacturing valve actuators in large numbers. The statistical data indicates that every year some of these manufactured actuators are found to be defective. The statistical data over the years also indicates that being sophisticated item no customer is prepared to buy valve actuator without a warranty. Therefore, warranty became integral part of the sale price of the valve actuator(s). In other words, warranty stood attached to the sale price of the product. These aspects are important. As stated above, obligations arising from past events have to be recognised as provisions. These past events are known as obligating events.”

27. The enunciation of the legal position with respect to provisioning was thus succinctly explained by the Supreme Court as relating to the accepted and recognised practise of an amount being set aside to cover the expected cost of a probable liability which an assessee may incur and factor in, provided it can be measured by a reasonable degree of estimation and subject to it being found that the assessee was burdened by a present obligation flowing from a past event coupled with the probability of an outflow of resources for purposes of settling such an obligation. The Supreme Court in Rotork, in light of the aforenoted basic precepts, upheld the provision which the assessee had made upon noticing that the statistical data was indicative of return of defective parts and it was on the basis of the said historical data that the assessee had made a provision. It thus found the action of the assessee, in the facts of that case to be justified.
28. As we view AS-29, we find that the said standard defines a provision to be a liability which can be me