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2009 (4) TMI 806 - AT - Income TaxPre-operative expenses - Power Purchase Agreement - abandon project - setting up of Speed Power Projects - aggregate capacity of about 5000 MW - Whether the business of the assessee could be said to have been set up on 18.11.1997, which was the date of agreement with MPEB - CIT(A) dismissed the assessee's appeal on this issue observing that since the expenditure was incurred by the assessee for setting up of a plant, the same was capital in nature and, therefore, could not be allowed as deduction to the assessee as revenue expenditure. HELD THAT - As it is evident from the facts noted earlier, the assessee had only entered into agreement with MPEB but MPEB finally backed out from the said agreement. This was only an assurance to the assessee for purchasing power from it subject to fulfillment of series of activities. It cannot be said that the assessee's business had been set up on 18.11.1997 when the agreement had been entered into with MPEB. It is true that entering into an agreement with MPEB was one of the essential activities for the business but this essential activity was in furtherance of setting up business. The assessee has pointed out that it had employed managerial and other staff in order to start the business. All these actions were essential for setting up of business because, admittedly, in order to priorities for Escrow Protection the assessee had submitted its offer for better terms on different parameters in pursuance to letter as mentioned in the written submissions filed by assessee placed on record. The assessee had undertaken this venture in pursuance to liberalized government policy which could not be implemented on account of change in policy decision itself and, therefore, it could not be said that the assessee's business had been set up because setting up implies that assessee is only few steps away from formal commencement of business. In this regard, we may refer to some decisions relied upon by Ld Counsels for the assessee In the case of Western India Seafood (P) Ltd. 1992 (8) TMI 68 - GUJARAT HIGH COURT , it was held that the test to be applied is as when a businessman would regard a business as having commenced and the approach must be from a common sense point of view. Applying this test also, we are of the opinion that till the assessee was prioritized for Escrow Protection and given a green signal by MPEB to go ahead with the project and in pursuance to that the assessee took its first step towards commencement of business, it cannot be said that the assessee's business had been set up. Whether the expenses once classified as capital expenditure in earlier years, could be treated as business expenditure in the year of abandonment of project - it is well settled commercial principle of accounting that the nature of expenditure is determined at the first instance when it is incurred and its nature cannot be altered on account of subsequent events. Once the expenditure has been classified as capital in nature, it cannot partake the character of revenue on account of supervening circumstances. Therefore, assessee's appeal is dismissed. Receipt of interest - Capital or revenue - AO treated the interest income as income from other sources as against the assessee's claim of treating the same as income from business and also disallowed the assessee's claim of set off of business loss. HELD THAT - The Hon'ble Supreme Court in the case Bokaro steel 1998 (12) TMI 4 - SUPREME COURT also considered the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. 1997 (7) TMI 4 - SUPREME COURT and held that the said decision was not applicable because in that case the money borrowed for business purposes was temporarily invested and utilized on interest, which the assessee could incur the manner he likes. However, in the case of Bokaro Steel, the utilisation of various assets of the company and the payments received for such utilization were directly linked with the activities of setting up steel plant of the assessee. These receipts inextricably linked with the setting up of the capital structure of the assessee and, therefore, they were held to be capital receipts going to reduce to cost of construction applying the decision of the Hon'ble Supreme Court in the case of Challapalli Sugar 1974 (10) TMI 3 - SUPREME COURT . In our opinion, this decision fully supports the claim of the assessee raised by way of additional ground. We have held in A.Y. 2002-03 that assessee's business had not been set up. Same situation persisted in A.Y. 2003-04 and, therefore, it cannot be said that the business had been set up in assessment year 2003-04. That being the factual state of affair, whatever expenditure had been incurred and whatever amount was received on security deposit were in capital field and could not be treated as revenue in nature. The decision in the case of Tuticorin Alkali cannot be applied because in that case there was no dispute regarding the setting up of the business. The business was treated as being set up and, therefore, the receipts by way of interest by deployment of surplus funds were held to be assessee's income. But till the business is set up, the receipts cannot be held to be in revenue field. The receipts upto the stage of setting up of business would go to reduce the cost of setting up of business. While parting we may observe that it would be travesty of justice if the assessee's expenditure upto the stage of setting up is treated as capital in nature but not the receipts during the same period. In view of above discussion, we allow the additional ground raised by assessee. In the result the assessee's appeal for AY 2002-03 is dismissed while appeal for AY 2003-04 is allowed.
Issues Involved:
1. Classification of pre-operative project expenditure as revenue or capital expenditure. 2. Determination of the date when the business was set up. 3. Treatment of interest income as business income or income from other sources. 4. Allowability of expenses incurred after the business is set up. 5. Re-classification of capital expenditure as revenue on account of abandonment of the project. Detailed Analysis: 1. Classification of Pre-Operative Project Expenditure as Revenue or Capital Expenditure: - The assessee company, incorporated in 1995, was involved in promoting and implementing a diesel-based power project. For the assessment year 2002-03, the assessee claimed a total loss, including pre-operative project expenditure written off as revenue expenditure. - The Assessing Officer (AO) disallowed this, stating the expenditure was capital in nature as it was incurred for setting up a plant. The AO emphasized that the entries in the books of account are binding and cannot be varied unless they are not conclusive or decisive. - The CIT(A) upheld the AO's decision, stating that since the business was not set up, there was no question of computing any business income or allowing expenses as revenue expenditure. 2. Determination of the Date When the Business Was Set Up: - The assessee argued that its business was set up long before the assessment years under consideration, citing various activities such as entering into a Power Purchase Agreement (PPA) with the Madhya Pradesh Electricity Board (MPEB), raising capital, and depositing a security amount. - The Tribunal held that the business is said to be set up when it is ready for take-off. However, merely entering into an agreement with MPEB did not mean the business was set up. The business activities undertaken were in furtherance of setting up the business, not its commencement. 3. Treatment of Interest Income as Business Income or Income from Other Sources: - For the assessment year 2003-04, the AO treated the interest income from a security deposit with MPEB as income from other sources, disallowing the set-off of business loss claimed by the assessee. - The CIT(A) upheld this, stating that since no business had commenced, the interest earned could not be considered business income. - The Tribunal, however, ruled that the interest income was inextricably linked with the process of setting up the business and, therefore, should be treated as a capital receipt, reducing the cost of setting up the business. 4. Allowability of Expenses Incurred After the Business is Set Up: - The assessee cited several judicial precedents to argue that expenses incurred after the business is set up should be allowed under Sections 30 to 37 of the Income Tax Act. - The Tribunal agreed that the expenses incurred after the business is set up are allowable as business expenditure. However, it held that in this case, the business was not set up, and hence, the expenses were rightly treated as pre-operative and capital in nature. 5. Re-Classification of Capital Expenditure as Revenue on Account of Abandonment of the Project: - The assessee argued that the pre-operative expenses should be reclassified as revenue expenditure due to the abandonment of the project. - The Tribunal held that the nature of expenditure is determined when it is incurred and cannot be altered due to subsequent events. Once classified as capital expenditure, it cannot be reclassified as revenue expenditure on account of abandonment. Conclusion: - The Tribunal dismissed the appeal for the assessment year 2002-03, upholding the classification of pre-operative expenses as capital expenditure. - For the assessment year 2003-04, the Tribunal allowed the appeal, treating the interest income as a capital receipt, thereby reducing the cost of setting up the business. The additional grounds raised by the assessee were admitted, and the main grounds became academic.
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