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Public Issue Expenses and its tax treatment

Sujit Talukder (service) (719 Points)

12 March 2009

A Limited company, engaged in real estate sector , incorporated in the year 2001 has incurred certain expenditure on Public issue Expenses. this amount is ariund Rs 4.00 crore. However, due to recent poor market condition, the company didnot bring the issue to the public and the IPO plan is scrapped now.

The company wants to write off the Public issue expenses.

Now my query is:

1. Can the company write off the failed IPO/Public issue expenses ? ( as per Comapnies Act/Accounting Standard provisions)

2. Whether such write off will be allowed under the Income Tax Act? If yes, under which section?

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16 Replies

Chitrank Jain (Senior Manager - Group Internal Audit) (146 Points)
Replied 12 March 2009

In my opinion it will be deductible under the residuary section i.e. 37(1) and it also satisfies all the conditions of that section.because this expense occured only because of the business, if it hadnt been there than there wouldnt have been any need to incur such expenses.

And one cannot treat it as capital expenses,had the IPO been succesful than only u can call it as capital expense and then deduction would have been allowed in 35D. Due to this expense no long term future benefit will br derived.

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deepak K Gujrati (CA-practice) (966 Points)
Replied 16 March 2009

In my opinion the company may debit such expenses to Profit & Loss Account. But it will not an allowable expenses. Sec 14 A is the charging section. It clearly states that any expenses can be allowed only when there is a corresponding income. In fact in normal course it was a deffered revenue expenditure and only 1/10th of the same can be debited in P & L a/c. But as the issue plan has failed it may be disallowed in view of section 14A.

deepak K Gujrati (CA-practice) (966 Points)
Replied 16 March 2009

Rajesh Kumar (Advocate- Tax) (7806 Points)
Replied 16 March 2009

Only revenue expenditure can be deducted under Section 37. Expenditure for raising additional capital by public issue is a capital expebditure [Vazir sultan 174 ITR 689 (AP)], Brook Bond [225 ITR 798 (SC), and hence not deductible under S 37. It should be treated as a capital expenditure.

Sujit Talukder (service) (719 Points)
Replied 16 March 2009

Originally posted by :Rajesh Kumar
"	Only revenue expenditure can be deducted under Section 37. Expenditure for raising additional capital by public issue is a capital expebditure [Vazir sultan 174 ITR 689 (AP)], Brook Bond [225 ITR 798 (SC), and hence not deductible under S 37. It should be treated as a capital expenditure.	"

Thanks Rajesh Kumar,

From your reply it is clear that the expenditure is a capital expenditure. Can we write off the ame u/s 35D ?

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deepak K Gujrati (CA-practice) (966 Points)
Replied 17 March 2009

Mr Rajesh

Please also suggest how it will be refelected in Balance Sheet specially when the IPO has been scrapped.

Chitrank Jain (Senior Manager - Group Internal Audit) (146 Points)
Replied 18 March 2009

Originally posted by :Rajesh Kumar
"	Only revenue expenditure can be deducted under Section 37. Expenditure for raising additional capital by public issue is a capital expebditure [Vazir sultan 174 ITR 689 (AP)], Brook Bond [225 ITR 798 (SC), and hence not deductible under S 37. It should be treated as a capital expenditure.	"

Mr Kumar, I have a doubt that such being a failed IPO the expenses incurred in its regard wont realise the co. any future benefit than how can we call it as capital expenditure?

If the IPO had been succesfult than I totally agree that it would have been a capital expenditure. Is there any other criteria for treating it as capital Expenditure?

TIA

Rajesh Kumar (Advocate- Tax) (7806 Points)
Replied 18 March 2009

Chitrank, I dont know accounting principles, so kindly bear with me if I am not very right in my treatements of accounts.

An expenditure is a valid expenditure, even if it fails in achieving its objective. Say, you spend something for marketing your product, the expenditure is a valid expenditure even if you failed in your effort. Thus an expenditure has to be treated on the basis of intention at the time of expenditure- its success or otherwise is irrelevant. Applying the principles in this particular case, it is a capital expenditure, irrespective of the fact whether IPO failed or succeeded.

Let me explain othet concept- profit shown in your balance sheet and profit for the purposes of Income Tax are two different things. For your balance sheet profit, you can treat this expenditure as per the principles of accounting principles, i.e. you can take is as a one time capital loss or amortise it in 5 years or 10yrs- i dont know. That is accounting problem.

I am concerned whether this expenditure will be allowed as depreciation over a period of time in calculating profit of business as per the calculation of income made under Section 29 of the IT Act. There is no direct provision. 35D, prima facie is not applicable. Let us keep this question open, think for a few days, may be we can find some way of claiming depreciation......

Chitrank Jain (Senior Manager - Group Internal Audit) (146 Points)
Replied 18 March 2009

Originally posted by :deepak
"	In my opinion the company may debit such expenses to Profit & Loss Account. But it will not an allowable expenses. Sec 14 A is the charging section. It clearly states that any expenses can be allowed only when there is a corresponding income. In fact in normal course it was a deffered revenue expenditure and only 1/10th of the same can be debited in P & L a/c. But as the issue plan has failed it may be disallowed in view of section 14A.	"

Mr. Deepak , I cant understand how u are applying Sec 14A? As per IT ACT Sec 14A applies for the "Expenditure incurred in relation to income not includible in total income". Whereas if this IPO had been successful the income from the funds emloyed would have been includible in the total income.

SUNEET V.MAHALE (CHARTERED ACCOUNTANT) (63 Points)
Replied 19 March 2009

Expenditure is treated as capital expenditure if

It is not a revenue expenditure
It has an enduring benefit (long lasting) which is not confined to one particular year of operation.
It is not deferred revenue expenditure.

Share Issue expenses are of capital nature and can be claimed as deduction only under Section 35D subject to applicability. Even if the share issue was made to raise working capital the expenses shall be regarded as of capital nature - BSL LTD (2003) 267 ITR 754 (CAL).

Expenditure has to be treated on the basis of intention at the time of making expenditure- its success or otherwise is irrelevant. Applying the principles in this particular case, the share issue expenses shall continue to be Share issue expenses i.e. of a capital nature, irrespective of the fact whether IPO failed or succeeded.

The land mark decision of Supreme Court in Empire Jute Co. Ltd. V/s CIT 124 ITR 1 has propounded that the test of the benefit of enduring nature may fail in certain cases and the expenditure giving rise to such benefit would still be deductible if the benefit is in the Revenue field.

As per the earlier quoted decision the raising of funds for working capital has also been held of a capital nature. Acquisition of assets in itself is a capital expenditure and that there is lack of enduring benefit on cancellation of the IPO sum up to the effect that the expense would not be deductible u/s 37(1) as the expense is of capital nature, not a deferred revenue expenditure either and also lacking enduring benefit which is not in the revenue field.

Please confirm if my understanding of the matter is tenable

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Vinay Chopra (CA ) (197 Points)
Replied 04 April 2009

It should be debited to Profit and loss and will be allowed in IT Act.. It has been judicially held in various cases in order to capitalise there should be an increase in capital employed by the company.

Chitrank Jain (Senior Manager - Group Internal Audit) (146 Points)
Replied 05 April 2009

Originally posted by :vinay chopra
"	It should be debited to Profit and loss and will be allowed in IT Act.. It has been judicially held in various cases in order to capitalise there should be an increase in capital employed by the company.	"

Sujit Talukder (service) (719 Points)
Replied 06 April 2009

Dear Vinay,

Can you provide the case laws?

Vinay Chopra (CA ) (197 Points)
Replied 06 April 2009

hi sujit,

i have given the answer taking into consideration decison given by suprememe court in GIC. In the said case the company had incurred expenses relating to issue of bonus shares. The court stated that in case of bonus issue there is no increase in capital employed by the company. Hence the criteria put forward by the court was Increment in Capital employed and not nature of expense. Therefore in case where issue falls out, there will be no increment in capital employed and hence chargeable to profits.