2009 (9) TMI 635 - HC - Income Tax

Disallowance - Revenue or capital expenditure - Regarding expansion of its existing business by setting up a weaving and spinning unit for manufacture of fabric and textiles - Since the setting up of the said proposed unit was abandoned during the previous year relevant to the assessment year 2000 -01, related project expenses amounting to Rs. 64,47,855 were written off and claimed deduction in computation of income for the assessment year 2000-01 under section 37(1) of the Act - The mere fact that the unit was proposed to be set up in the State of Karnataka, which was geographically distant from the existing unit of the appellant, could not be a ground to hold that what was proposed to be set up was a different unit altogether - The proposed business was not an individual business but vertical expansion of the present business - Since the project was abandoned, no new asset also came to be created In the previous year relevant to the assessment year 2000-01, the payment made to Mc. kinsey was claimed deduction by the appellant - Tribunal has accepted the fact that even when there was no formal written agreement with M/s. McKinsey and Co., the report was submitted by the said company for the task assigned - Once it is accepted as a fact that the assignment given to the said consultants was for the purpose of improving operational efficiencies and was not to incur any enduring benefit in capital field but to carry on the existing business more efficiently and profitably, the irresistible conclusion which follows is that such expenditure was allowable as business expenditure - All the appeals are dicided in the favour of the assessee

Issues Involved:
1. Whether the expenditure on setting up a weaving and spinning unit in Karnataka was capital in nature.
2. Whether the consultancy fee paid to McKinsey and Co. for an operational efficiency and profitability study was capital in nature.

Issue-wise Detailed Analysis:

Issue 1: Expenditure on Setting Up a Weaving and Spinning Unit in Karnataka

The appellant, engaged in the manufacture of yarn and polyester, sought to expand its operations by setting up a weaving and spinning unit in Karnataka. The project, however, was abandoned due to the inability to procure land, leading to the write-off of related expenses amounting to Rs. 64,47,855, which was claimed as a deduction under section 37(1) of the Act.

The Assessing Officer (AO) disallowed the deduction, classifying the expenses as capital in nature. This decision was upheld by the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal (the Tribunal), citing the geographical distance of the proposed unit from the existing business and the lack of inextricable linkage between the two.

The appellant argued that the proposed unit was an integral part of its existing business, authorized by its memorandum and articles of association, and intended for vertical integration. The decisive test, as per the appellant, was unity of control, interlacing of funds, and common management, irrespective of geographical distance.

The court referenced the case of CIT v. Priya Village Roadshows Ltd. [2011] 332 ITR 594, where expenses for feasibility studies of projects that were eventually shelved were treated as revenue expenditure. The court emphasized that if the expenditure is incurred for the same business and no new asset is created, it should be treated as revenue expenditure.

Applying this principle, the court concluded that the expenses incurred by the appellant were revenue in nature. The proposed unit was a vertical expansion of the existing business, with common administration and funds, and no new asset was created as the project was abandoned.

Issue 2: Consultancy Fee Paid to McKinsey and Co.

The appellant engaged McKinsey and Co. for a detailed operational efficiency and profitability study, but the assignment was terminated early, resulting in a payment of Rs. 74,04,128, which was claimed as a deduction.

The AO disallowed the deduction, viewing the expenditure as capital in nature. This decision was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal, which cited the lack of a written agreement and the incomplete nature of the study as reasons for their decision.

The appellant contended that the purpose of the study was to improve operational efficiency and profitability, not to acquire any capital asset or enduring advantage. The court noted that the Tribunal accepted the existence of a report from McKinsey and Co., which outlined the scope of the study.

The court found the Tribunal's reliance on the absence of a written agreement inappropriate. The report itself indicated that the study aimed to improve operational efficiencies and profitability, aligning with the criteria for revenue expenditure.

The court referenced CIT v. Praga Tools Ltd. [1986] 157 ITR 282 (AP) and CIT v. Crompton Engineering Co. Ltd. [2000] 242 ITR 317 (Mad), which supported the classification of such expenses as revenue expenditure.

Conclusion:

The court ruled in favor of the appellant on both issues, allowing the expenses related to the abandoned unit and the consultancy fee as revenue expenditure. The orders of the lower authorities were set aside, and the appellant was entitled to treat these expenditures as revenue expenditure for the relevant assessment year.

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