2020 (9) TMI 612 - AT - Income Tax

Pre-operative expenses disallowance - assessee had not commenced its business activities of manufacturing/production - HELD THAT - The assets required to commence the business of trading in the form of computer, furniture etc were also acquired by the assessee and it had appointed necessary personnel to carry on its business operations. The premises was also taken on lease by the assessee to carry on its business and although the CIT(A) has raised some objection regarding the size of the said premises being insufficient for setting up of the assessee s business, we find merit in the contention of assessee that the said objection is not sustainable keeping in view the nature of the assessee s business. All these steps taken by the assessee-company during the year under consideration especially the major step taken by procuring the goods from its parent company on 21.02.2011, in our opinion, were sufficient to show that the business was duly set-up and it was ready to commence. As observed that the authorities below, however, could not properly appreciate this position and treated the expenses in question claimed by the assessee as pre-operative expenses on the ground that the business had not commenced in the absence of any sale made by the assessee during the year under consideration. As held in the case of CIT vs. Sarabhai Management Corporation Ltd. 1991 (8) TMI 6 - SUPREME COURT where the business activities constituted of acquisition of property, putting it into shape and lease it out, it could not be said that the business was not setup till the first lease took place. As held that earlier part of the activities, namely, engaging staff, buying the equipment and making the staff familiar therewith are all part of the business and the business can be said to be set-up even earlier. In the case of Western India Vegetable Products Ltd. vs. CIT 1954 (3) TMI 59 - BOMBAY HIGH COURT held that for the purpose of the Indian Income-tax Act, the setting up a business and not the commencement is to be considered. It was held that when a business is established and is ready to commence business, then it can be said that business has been set up. Explaining further, the Hon ble Bombay High Court clarified that there may be an interval between the setting up of the business and the commencement of business and all the expenses incurred during that intervening period would be permissible deduction. We are of the view that the business of the assessee was set-up on 21.02.2011 and it was, therefore, eligible for deduction on account of expenses incurred after that date. We delete the disallowance made by the AO and confirmed by CIT(A) by treating the expenses incurred by the assessee-company under the head personnel cost, general and administrative expenses as pre-operative expenses and allow this appeal of the assessee. - Decided in favour of assessee.

Issues Involved:
1. Disallowance of ?38,39,218/- as pre-operative expenses.
2. Determination of whether the business was set-up or commenced.
3. Allowability of general and sales promotional expenses under Section 37 of the Income Tax Act.

Detailed Analysis:

1. Disallowance of ?38,39,218/- as Pre-operative Expenses:
The primary issue in this case is the disallowance of ?38,39,218/- made by the Assessing Officer (AO) and confirmed by the Commissioner of Income Tax (Appeals) [CIT(A)] on account of pre-operative expenses. The assessee, a company involved in trading and distribution of Completely Knocked Down (CKD) parts of motorbikes, filed a return declaring a loss of ?35,23,876/-. The AO disallowed ?84,12,461/- as "pre-operative expenses" and allowed ?38,93,218/- as deduction. However, since the assessee showed no sales or turnover during the year, the AO questioned the deduction claim and subsequently disallowed the ?38,93,218/- as pre-operative expenses.

2. Determination of Whether the Business was Set-up or Commenced:
The assessee argued that its business was set-up on 21.02.2011, the date it made its first purchase of CKD units from its parent company. The assessee had obtained various registrations, leased premises, and appointed staff prior to this date. The CIT(A) disagreed, noting that the leased premises were insufficient for the business's nature, the invoice did not appear authentic, and customs duties were paid after the financial year ended. Consequently, the CIT(A) upheld the AO's disallowance, concluding that the business had not been set-up.

The Tribunal, however, found merit in the assessee's argument, noting that the steps taken by the assessee, including obtaining necessary registrations, acquiring assets, and hiring staff, were sufficient to establish that the business was set-up. The Tribunal referenced the Hon’ble Supreme Court's decision in CIT vs. Sarabhai Management Corporation Ltd. and the Hon’ble Bombay High Court's decision in Western India Vegetable Products Ltd. vs. CIT, which clarified that business expenses incurred after setting up the business but before its commencement are deductible.

3. Allowability of General and Sales Promotional Expenses under Section 37:
The assessee contended that under Section 37 of the Income Tax Act, any expenditure laid out wholly and exclusively for business purposes is allowable, regardless of immediate benefits. The assessee cited several judicial precedents, including the Supreme Court's decision in Easter Investments Ltd. vs. CIT, which affirmed that expenditures need not result in immediate benefits to be deductible. The Calcutta High Court in Sarda Plywood Industries Ltd. vs. CIT and the Gauhati High Court in CIT vs. Williamson Tea (Assam) Ltd. further supported this view, stating that expenditures for business promotion are deductible even without immediate sales.

The Tribunal agreed with the assessee, noting that the business was set-up on 21.02.2011, and thus, expenses incurred after this date were deductible. The Tribunal emphasized that the AO and CIT(A) failed to appreciate the distinction between setting up and commencing a business.

Conclusion:
The Tribunal concluded that the assessee's business was set-up on 21.02.2011, and expenses incurred after this date should be allowed as deductions. Consequently, the disallowance of ?38,93,218/- was deleted, and the appeal of the assessee was allowed. The Tribunal's decision was pronounced on 09th September 2020.

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