2017 (10) TMI 879 - AT - Income Tax

Allowable deduction u/s 37(1) - allowability of employee expenses as business expenditure - commencement of activities in trading - Held that - Assessee in the course of Assessment Proceedings furnished the complete details in respect of the expenses incurred by the assessee in respect of the employee cost relating to trading activity. On a specific query by the Assessing Officer the assessee also replied why the employee expenses in respect of trading activity was claimed as deduction against profit earned in trading business and why such expenses have not been capitalized, stating that none of these expenses related to the proposed manufacturing facility but were incurred in the operations of trading activity. Assessing Officer and the First Appellate Authority have not appreciated the submissions of the assessee in a proper perspective. The Memorandum of Association clearly shows that assessee is into business of manufacturing, producing, buying, purchasing, selling, distributing, supplying, merchandising, trading, importing, exporting or otherwise dealing in chemicals, chemical compounds, organic and inorganic forms in solid, liquid and gaseous etc., Therefore, assessee is into composite business of manufacturing as well as trading into chemicals. Since the assessee is into the business of trading and manufacturing of chemicals and since the assessee has commenced its activities in trading during this Assessment Year the expenses relating to the trading activities cannot be denied for the reason that assessee has not commenced its manufacturing operations of chemicals. We also see no reason for denying the expenses simply because assessee has incurred huge expenses towards salary and other expenses in trading activity which has only commenced during this Assessment Year. Thus, we direct the Assessing Officer to accept the assessee s claim for expenses as returned by the assessee in its return of income and allow the loss claimed by the assessee on account of the claim for such expenses. Grounds raised by the assessee are allowed.

Summary

Issues Involved:

1. Disallowance of employee expenses.
2. Disallowance of other expenses such as professional fees, rent, security, telephone, and conveyance.

Detailed Analysis:

1. Disallowance of Employee Expenses:

The assessee contested the disallowance of employee expenses by the Learned Commissioner of Income Tax (Appeals) [Ld.CIT(A)], arguing that these expenses were incurred wholly and exclusively for the purpose of the trading business and should be allowable as a deduction under Section 37(1) of the Income Tax Act. The Assessing Officer (AO) had rejected the claim for loss, stating that the assessee had not commenced its business activities but was in the process of setting up manufacturing facilities. The AO observed that the assessee had shown purchases and sales of traded goods with a profit of ?5,12,666/-, while claiming large expenses like employee costs, which he deemed not allowable under Section 37(1).

On appeal, the Ld.CIT(A) upheld the AO's decision, noting that the assessee was setting up a manufacturing facility and had only commenced trading operations. The Ld.CIT(A) highlighted discrepancies in the appointment letters of employees, particularly Mr. M.R. Sawant, whose salary was deemed disproportionate to the trading activities conducted.

The Tribunal, however, found that the assessee provided detailed explanations and documentation showing that the employee expenses were related to trading activities and not to the manufacturing setup. It was noted that the assessee was in a composite business of trading and manufacturing chemicals and had commenced trading operations during the assessment year. The Tribunal referred to the Memorandum of Association and past case law (CIT v. Ralliwof Ltd.) to conclude that expenses related to trading activities should be allowed even if manufacturing had not commenced. Consequently, the Tribunal directed the AO to allow the employee expenses claimed by the assessee.

2. Disallowance of Other Expenses:

The assessee also challenged the disallowance of other expenses such as professional fees, rent, security, telephone, and conveyance, which were disallowed on an ad-hoc basis by the Ld.CIT(A). The assessee argued that these expenses were incurred wholly and exclusively for the trading business and should be deductible under Section 37(1).

The Tribunal noted that the assessee had submitted comprehensive details regarding these expenses and the functions of the principal staff involved in trading operations. The Tribunal found that the AO and Ld.CIT(A) had not properly appreciated the submissions and documentation provided by the assessee. It was observed that the trading activities had commenced, and the expenses incurred were necessary for these operations.

The Tribunal held that the disallowance of these expenses was not justified simply because the assessee had incurred significant costs in the first year of trading operations. The Tribunal directed the AO to accept the expenses as claimed by the assessee and allow the loss reported in the return of income.

Conclusion:

The Tribunal allowed the appeal of the assessee, directing the AO to accept the claimed expenses and the resultant loss for the assessment year 2012-13. The judgment emphasized that expenses related to trading activities should be allowed even if manufacturing operations had not commenced, provided the business was a composite one involving both trading and manufacturing.