2019 (4) TMI 816 - HC - Income Tax

Revision u/s 264 - commencement of business - allowability of expense u/s 37(1) - established by the government for specific purpose of developing old stations - entire major services are outsourced to consultants - during the assessment year the assessee engaged all key personnel. CEO took charge sometime in the beginning of November, 2012. It finalised a tender for obtaining financial bid and tender advisory service on 17.12. 2013 and the first consultant was appointed on 01.02.2013 - AO disallowed three items of expenditure claimed as deduction, i.e., depreciation, preliminary expenses, and employees remuneration - HELD THAT - There is no bright line that can be determinative as to when business commences. In case of the service sector, where the entity has involved itself in various kinds of steps, some of which are preliminary to setting up the main substantial commercial venture, the linkage between these preliminary steps and nature of the ultimate activity may be a relevant factor to be taken into account. Therefore, Carefour 2014 (9) TMI 793 - DELHI HIGH COURT dealt with this trading related aspect and stated that even certain kinds of preliminary steps, such as engaging in negotiation or employment of personnel, could be relevant even though actual activity might not be involved. Keeping this principle in mind, this Court is of the opinion that the petitioner s activity, which it claims to be preliminary steps towards the fulfillment of the purpose, which is embodied in the MoU and extracts of which have been reproduced above, clearly indicates that it had set up its business and that these steps were for the ultimate fulfillment of its purposes, which was the preparation of development plans leading to the projects. The Principal Commissioner of Income Tax, in the impugned order, was plainly wrong in holding otherwise. For the aforesaid reasons, we are of the opinion that this writ petition is to succeed. The impugned order of the CIT, as well as the AO are set aside.he matter is remitted to the AO to give tax effect and to ensure that the deduction claims are appropriately granted.

Summary

Issues Involved:
1. Disallowance of expenditure claimed as deductions (depreciation, preliminary expenses, and employees’ remuneration).
2. Determination of whether the petitioner had set up its business during the assessment year 2013-2014.

Issue-Wise Detailed Analysis:

1. Disallowance of Expenditure Claimed as Deductions:
The petitioner challenged the assessment order by the Assessing Officer (AO) for the assessment year 2013-2014, which disallowed three items of expenditure claimed as deductions: depreciation, preliminary expenses, and employees’ remuneration. The AO observed that the petitioner declared a loss of ?44,70,035/- and claimed expenditure amounting to more than ?1.92 crores without any business income, categorizing an amount of ?85,83,365/- as income from other sources. The petitioner’s revision petition under Section 264 of the Income Tax Act, 1961, was declined by the Principal Commissioner of Income Tax (CIT).

2. Determination of Whether the Petitioner Had Set Up Its Business:
The petitioner argued that it had set up its business by taking various preliminary steps, including the appointment of key personnel, preparation of a draft model Development Agreement, and initiation of the process to tender financial and advisory services. However, the CIT rejected this claim, affirming the AO's view that the business was not established as essential elements like financial and bid advisory services and consultants for architectural and technical feasibility studies were not in place until after the assessment year.

The CIT’s order detailed the timeline of key activities:
- Appointment of key personnel was completed by November 12, 2012.
- The draft model development agreement was finalized by October 31, 2012.
- Financial and bid advisory services were appointed only in April 2013.
- The first consultant for architectural and technical feasibility studies was appointed on February 1, 2013.

Based on these timelines, the CIT concluded that the petitioner’s business was not set up by the end of the previous year, and therefore, no expenses could be allowed under Section 37(1) of the Act. Only amortization of certain preliminary expenses under Section 35D was permitted after the commencement of business.

Legal Precedents and Court’s Analysis:
The petitioner’s counsel argued that the CIT’s view was erroneous in law, citing judgments from the Delhi High Court, which emphasized that for service entities, preliminary steps towards setting up a business could be sufficient to claim business expenditure. The court referred to several judgments:
- Commissioner of Income Tax vs. Hughes Escorts Communications (2007) 311 ITR 253: Highlighted the distinction between ‘setting up’ and ‘commencement’ of business, stating that expenses incurred after setting up but before commencement are permissible deductions.
- Commissioner of Income-tax-IV vs. Dhoomketu Builders and Development Private Limited (2013) 368 ITR 680: Held that business was set up when the assessee took steps towards its commercial activity, even if the actual business did not commence.
- Carefour WC & C India Pvt. Ltd. vs. Deputy Commissioner of Income Tax (2015) 368 ITR 692: Stated that preliminary steps like engaging personnel and planning could indicate the setting up of a business.

The court concluded that the petitioner’s activities during the assessment year were preliminary steps towards fulfilling its business purpose, as outlined in the MoU between its promoters. These steps included appointing key personnel and initiating processes for financial and advisory services, indicating that the business was set up.

Conclusion:
The court held that the Principal Commissioner of Income Tax was incorrect in rejecting the petitioner’s claim and set aside the orders of the CIT and AO. The matter was remitted to the AO to give tax effect and ensure that the deduction claims were appropriately granted. The writ petition was allowed in these terms.