2021 (4) TMI 277 - HC - Income Tax

Allowability of pre-operative expenses - date of business of the assessee as set-up - reference to steps which the assessee had taken in AY 2008-2009 such as getting itself incorporated and having a PAN number and TAN number allotted to it - HELD THAT - The reason that we have only emphasised on the steps taken by the assessee in the previous AY, i.e., AY 2009-2010 is to show that, both, CIT(A) and the Tribunal were correct in concluding, in our view, that the assessee had set-up its business and was ready to carry on the same in the previous AY, i.e., AY 2009-2010. Revenue's submission that the business of the assessee was set-up only on 29.10.2009, in our opinion, is not correct. The submission is predicated on one singular fact, which is, that the assessee had launched its experience centre i.e. physical outlet on 29.10.2009. As correctly argued by assessee that there is a difference between setting-up of business and commencement of business. The fact that the assessee had executed lease deeds for its premises, engaged senior employees, carried out local purchase, and sales could not have been possible had it not set-up its business. The fact that the assessee had set-up an experience centre in the FY 2009-2010, which was another mode or platform for selling its goods, cannot have us hold that the assessee had not set-up its business in the previous AY. Therefore, the stated absence of the assessee on an online platform, in our view, is non-sequitur in the fact situation obtaining in the instant case. Disallowance of advertising expenditure - HELD THAT - The submissions made on behalf of the revenue lacked conviction. Although, Revenue did draw our attention to the AO s view qua the issue, which was, that the advertising expenditure had been incurred to build a brand, i.e., goodwill and therefore, should not be allowed as a deduction, it does not impress us. There is nothing on record to show that the expenditure incurred by the assessee, towards advertising, was not laid out or expended, wholly and exclusively, for the purposes of business. The expenditure incurred, in our view, being a business expenditure, which was incurred wholly and exclusively for the purposes of business, and did not lead to the creation of a capital asset in the assessment year in issue, ought to have been allowed by the AO. The rationale adopted by the A.O. for disallowing the expenditure was completely flawed. Goodwill, which is built, based on the reputation acquired by the business over the years, is an intangible asset, which is monetized, ordinarily, when the business is sold. Therefore, for the A.O. to disallow advertising expenditure on this basis was completely erroneous. Thus, the deletion of the addition made by the A.O. qua expenditure incurred on advertising both by the CIT(A) and the Tribunal, to our minds, was in order. The extent of expenditure on advertising does not, in our view, decide as to whether the expenditure incurred is of a revenue nature or of a capital nature. There is nothing on record, as indicated above, to show that a capital asset was created. In sum, it fulfilled the criteria for allowability of such expenditure, as provided, in Section 37 of the Act. The expenditure was incurred for the subject AY and, therefore, the addition made by the A.O. was rightly deleted by the CIT(A); a decision which was sustained by the Tribunal. Assessee appeal allowed.

Summary

Issues Involved:

1. Whether the Income Tax Appellate Tribunal erred in deleting the addition made qua pre-operative expenses by holding that the expenses incurred were legitimate business expenditure.
2. Whether the Tribunal was justified in deleting the addition made qua advertising expenses by failing to consider the fact that these expenses were incurred to build goodwill, which is a capital asset.

Issue-Wise Detailed Analysis:

1. Pre-operative Expenses:

The primary issue addressed was whether the Tribunal erred in deleting the addition made by the AO concerning pre-operative expenses. The assessee had filed its return for AY 2010-2011, declaring a loss. The AO, during scrutiny, added back pre-operative expenses amounting to ?3,50,51,978/-, arguing that these expenses were incurred before the commencement of business.

The assessee contended that there is a difference between setting-up of business and commencement of business. The CIT(A) and the Tribunal concluded that the business was set-up in the previous AY (2009-2010), based on various steps taken by the assessee, including obtaining an IEC, executing lease deeds, hiring employees, making local purchases, and sales. The Tribunal sustained the CIT(A)’s order, allowing the deduction of pre-operative expenses.

The Court agreed with the Tribunal and CIT(A), noting that the assessee had undertaken several business activities in the previous AY, indicating that the business was set-up. The Court rejected the revenue’s argument that the business commenced only when the experience centre was launched on 29.10.2009. The Court emphasized the distinction between setting-up and commencement of business and held that the expenses incurred prior to 29.10.2009 were legitimate business expenditures.

2. Advertising Expenses:

The second issue was whether the Tribunal was justified in deleting the addition made by the AO concerning advertising expenses amounting to ?60,39,950/-. The AO had disallowed these expenses, arguing that they were incurred to build goodwill, a capital asset.

The assessee argued that the advertising expenses were incurred wholly and exclusively for business purposes and should be allowed as a deduction under Section 37 of the Act. The CIT(A) and the Tribunal accepted this argument and allowed the deduction.

The Court upheld the Tribunal’s decision, stating that there was no evidence to suggest that the advertising expenses were not incurred wholly and exclusively for business purposes. The Court noted that goodwill is an intangible asset built over time and does not arise from one-time advertising expenditure. The Court concluded that the AO’s rationale for disallowing the expenditure was flawed and that the expenses met the criteria for allowability under Section 37 of the Act.

Conclusion:

The Court answered both substantial questions of law in favor of the assessee and against the revenue. The appeal was disposed of accordingly, and all pending applications were closed.