2014 (9) TMI 6 - HC - Income Tax

Effective date for set up of business 1.4.2004 or 30.6.2004 - Approval as 100% EOU taken and operations commenced from 1.4.2004 - AO and ITAT observed that the appellant assessee had commenced its operations only from 1.6.2004, i.e. the date on which the appellant assessee entered into service agreement with its parent company - AO and ITAT capitalized the expenditure incurred between 1.4.2004 to 31.5.2004 - Held that - Keeping in view the nature of business activity of the appellant-assessee, it cannot be held that training, imparting skills to employees recruited, or, testing their performance can be treated as a pre-setup expenditure - The appellant assessee had either employed or taken help of trainers/seniors for the said purpose - The moment employees were recruited and enrolled, and infrastructure to use their service was in place, setup was complete - It was indicative of the fact that business operations had been setup. The reasoning given by the Tribunal and the AO cannot be said to show that the business of the appellant-assessee had not been setup - The business of the appellant had been setup as the appellant-assessee had acquired the necessary infrastructure from their sister concern, M/s Agilis, and had also started making payment of salary and wages - This training was given by professional experts under the supervision and control of the appellant-assessee - The moment the operations were commenced, the business had been setup and the subsequent rendering of service to third parties would be at a later date when the actual services were rendered to the parent/holding company relying upon CIT Vs. Saurashtra Cement and Chemical Industries Limited 1972 (8) TMI 19 - GUJARAT High Court . Upon recruitment of employees, the factum that expenditure under the different heads, as noticed above, was incurred is indicative that business was set up - Training to the employees was given to ensure that when the work was undertaken and performed, there were no glitches, trouble or problems - It is not indicative of the fact that necessary infrastructure was not there and actual business could not have commenced or was not set up - Training was post set up as the employees were recruited - The training continued even when the business was in operation. It was part and parcel of the business activities as a service provider Decided in favour of assessee.

Issues Involved:
1. Determination of the date of business setup.
2. Classification of expenses as revenue or capital expenditure.
3. Interpretation of "setting up" vs. "commencement" of business.

Issue-Wise Detailed Analysis:

1. Determination of the Date of Business Setup:

The primary issue was whether the appellant-assessee had set up its business on 1st April 2004 or 1st June 2004. The appellant-assessee, a subsidiary of M/s Omniglobe International, USA, claimed that it started operations on 1st April 2004 and incurred expenses amounting to Rs. 59,02,448/- during April and May 2004. The Assessing Officer and Tribunal held that the business was set up on 1st June 2004, the date of the service agreement with the parent company, and capitalized the expenses incurred before this date. The Commissioner of Income Tax (Appeals) decided in favor of the appellant-assessee, recognizing the expenses as revenue expenditure.

2. Classification of Expenses as Revenue or Capital Expenditure:

The appellant-assessee incurred various expenses, including salary and wages, employer contributions to PF and ESI, administrative charges, medical expenses, housekeeping, generator maintenance, professional charges, recruitment, computer hire, electricity, water, and pantry charges. These expenses were disallowed as revenue expenditure by the Assessing Officer and Tribunal but were considered revenue expenditure by the Commissioner of Income Tax (Appeals) after examining the nature of the business and the activities undertaken during April and May 2004.

3. Interpretation of "Setting Up" vs. "Commencement" of Business:

The judgment emphasized the distinction between "setting up" and "commencement" of business, referring to precedents such as Western Indian Vegetable Products Ltd. vs. Commissioner of Income Tax and other relevant cases. The court reiterated that "setting up" means establishing a business to the point where it is ready to commence operations, while "commencement" refers to the actual start of business activities. The court noted that the appellant-assessee had recruited employees, incurred substantial expenses, and had the necessary infrastructure in place by 1st April 2004, indicating that the business was set up by this date.

Detailed Analysis:

Nature of Business and Activities Undertaken:

The appellant-assessee was engaged in Business Process Outsourcing (BPO) services. It entered into an agreement with M/s Agilis Information Technologies International Pvt. Ltd. to use their premises and infrastructure from 1st April 2004. The appellant-assessee incurred expenses on salaries, recruitment, housekeeping, electricity, water, and internet charges, which were essential for setting up the business.

Evidence and Documentation:

The appellant-assessee provided detailed evidence, including agreements, ledger accounts, and particulars of expenses incurred during April and May 2004. The Commissioner of Income Tax (Appeals) accepted this evidence under Rule 46A of the Income Tax Rules, 1962. The Tribunal did not dispute the evidence but failed to consider the agreement between the appellant-assessee and M/s Agilis, leading to an incomplete assessment.

Training and Recruitment:

The appellant-assessee argued that the expenses incurred in April and May 2004 were for training newly recruited employees, which was integral to setting up the business. The court accepted this argument, noting that training is a crucial part of the BPO industry and indicative of business setup. The court compared training to trial production in a manufacturing setup, emphasizing that the business setup was complete when employees were recruited and training commenced.

Precedents and Legal Interpretation:

The court referred to several precedents, including CIT vs. Samsung India Electronics Ltd., CIT vs. L.G. Electronics (India) Ltd., and CIT vs. ESPN Software India P. Ltd., which distinguished between setting up and commencement of business. The court concluded that the appellant-assessee's business was set up on 1st April 2004, as it had the necessary infrastructure and had started training employees.

Conclusion:

The court held that the appellant-assessee's business was set up on 1st April 2004, and the expenses incurred during April and May 2004 were revenue expenditures. The court answered the question of law in favor of the appellant-assessee and against the respondent-Revenue, emphasizing that training and recruitment are integral to setting up a BPO business. The judgment underscored the importance of considering the nature of business activities and the factual matrix in determining the date of business setup.

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