2010 (5) TMI 649 - AT - Income Tax

Disallowance of business expenditure - Held that - Western India Vegetable Products Ltd. v. CIT 1954 (3) TMI 59 - BOMBAY HIGH COURT wherein observed that when a business is established and is ready to commence business then it can be said of that business that it is set up. But before it is ready to commence business it is not set up. But there may be interregnum there may be a interval between a business which is set up and a business which is commenced and all expenses incurred after the setup of the business and before commencement of the business all expenses during the interregnum would be permissible deduction under section 10(2) of the Income-tax Act - assessee in the present case entered into agreements of sale of the gases with other parties in the assessment year in question or before. Since the assessee has been able to satisfy that it started securing orders for sale of gases therefore the assessee had commenced its business accordingly - no infirmity in the order of the CIT(Appeals) in allowing deduction of the expenditure in this case the Departmental appeal stands dismissed.

Summary

Issues Involved:
1. Whether the expenses incurred by the assessee were in the nature of pre-operative expenses and should be capitalized.
2. Whether the business of the assessee had commenced during the assessment year in question.

Issue-wise Detailed Analysis:

1. Pre-operative Expenses and Capitalization:
The primary issue was whether the expenses amounting to Rs. 26,40,31,938 incurred by the assessee were pre-operative expenses that should be capitalized or if they were allowable as business expenses. The Assessing Officer (AO) contended that the assessee did not carry out any commercial transactions such as buying or selling LNG or CNG gas during the year, thus categorizing these expenses as pre-operative. The AO relied on precedents like *Challapalli Sugars Ltd. v. CIT* and *Mining Machinery & Explosives (P.) Ltd. v. CIT* to argue that these expenses were related to setting up the business and should be capitalized.

However, the Commissioner of Income-tax (Appeals) (CIT(A)) disagreed, noting that the assessee had engaged in significant preparatory activities such as market exploration, entering into memorandums of understanding (MoUs), and negotiations for long-term transport arrangements. The CIT(A) concluded that these activities indicated that the business had commenced, and therefore, the expenses should be treated as revenue expenses, not capitalized. This decision was based on the peculiar nature of the assessee's business, where initial steps and market exploration were critical.

2. Commencement of Business:
The second issue was whether the business of the assessee had commenced during the assessment year. The AO argued that no business activity had commenced as there was no transaction of purchase or sale of gas. The AO's stance was supported by the decision in *Akzo Nobel Car Refinishes India (P.) Ltd. v. Dy. CIT*, which emphasized that mere incorporation does not equate to business commencement.

The assessee, however, provided evidence of several MoUs and agreements for the supply of gas, arguing that these activities constituted the commencement of business. The CIT(A) accepted this argument, noting that the business had indeed commenced as the assessee had started securing orders for gas. This view was supported by the ITAT Ahmedabad Bench's decision in *General Motors India Ltd. v. Jt. CIT*, which held that business commencement occurs as soon as the entity starts securing orders.

Conclusion:
The ITAT upheld the CIT(A)'s decision, confirming that the assessee's business had commenced during the assessment year, and the expenses incurred were revenue expenses. The ITAT noted that the AO's reliance on certain precedents was misplaced as the facts of the case indicated that the assessee had commenced its business activities. Consequently, the appeal by the Revenue was dismissed, affirming that the expenses should be allowed as business expenses under the head "revenue" and not capitalized.