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Disallowance of expenses claimed to have been incurred u/s 35D is justified where assessee-company’s business operations are yet to commence: ITAT

2019-TIOL-1552-ITAT-MAD

IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH ‘A’ CHENNAI

ITA No.2301/Chny/2018
Assessment Year: 2015-16

M/s MOTREX AUTOMOTIVE INDIA PVT LTD
FLAT NO 2 AND 3, VELLANTHANGAL VILLAGE
IRUNGATTUKOTTAI, SRIPERUMBUDUR, CHENNAI-602105
PAN NO: AAJCM3791N

Vs

INCOME TAX OFFICER
CORPORATE WARD-4(1), CHENNAI-600034

George Mathan, JM & S Jayaraman, AM

Date of Hearing: June 10, 2019
Date of Decision: June 10, 2019

Appellant Rep by: Mr Y Sridhar, CA & Mr Vijaya Sriram, CA
Respondent Rep by: 
Mr AR V Sreenivasan, JCIT

Income Tax – Section 35D.

Keywords – Non Commencement of business activities – Revenue Expenses.

THE assessee company, engaged in the business of assembly of car navigating systems and fittings of such navigation systems in cars, filed return for relevant AY. The assessment was completed u/s 143(3) of Act. The assessee was unsatisfied with action of the AO, in allowing the expenses (incurred after the date of “set up” of the business) u/s 35D, instead of allowing it fully in the previous year in which the business was “set up”. On appeal, CIT(A) upheld the order of AO.

On appeal, Tribunal held that,

Whether if the business activities of the assessee company are yet to start, the AO is right in disallowing the assessee’s claim of Revenue expenditure and allowing expenses u/s 35D of Act – YES : ITAT

++ in the Director’s Report, under the highlights of performance, it has been categorically admitted that the year ended 31.03.2015 is the first year of operation of the assessee company and the business activities are yet to be commenced. It has also mentioned that the Directors are confident to commence the business activities soon. The turnover of the assessee company has been shown at NIL. The Revenue is shown at NIL. The Excise Duty (products which have dealt with by the assessee being an excisable product) is shown at NIL. Salaries are shown at 13,51,285/-. Staff welfare is shown at Rs.1,61,308/-. There were no details about number of employees. The assessee is dealing with M/s. Hyundai Motor India Ltd., and the salary payment is to only one employee being the Director. The decision the case of Ascendas is not applicable in the assessee’s case as the primary requirement of funds and the certificate for inflow has been received only on 28.03.2015 and nothing has been shown to prove commencement of business. Thus, clearly nothing has been shown that the assessee has started any business activity during the relevant assessment year. This being so, no reason was found to interfere with the order of the CIT(A) and consequently, uphold the same. In the result, the appeal filed by the assessee stands dismissed.

Assessee’s appeal dismissed

ORDER

Per: George Mathan, JM

This is an appeal filed by the assessee against the Order of the Commissioner of Income Tax (Appeals)-8, Chennai, in ITA No.44/17-18 dated 23.05.2018 for the AY 2015-16.

2. Shri AR.V.Sreenivasan, JCIT, represented on behalf of the Revenue and Shri Y.Sridhar, CA & Shri Vijaya Sriram, CA represented on behalf of the assessee.

3. It was submitted by the Ld.AR that the only issue in the assessee’s appeal is against the action of the Ld.CIT(A) in confirming the treatment of the Revenue expenditure claimed to the extent of Rs.48,72,391/- u/s.35D of the Act. It was a submission that the assessee company is engaged in the business of assembly of car navigating systems and fittings of such navigation systems in cars. The Ld.AR placed written submissions before us, which are as follows:

The Appellant has contested the action of the Assessing Officer, in allowing the expenses (incurred after the date of “set up” of the business) under Section 35D, instead of allowing it fully in the previous year in which the business has been “set up”.

1. At the outset, the Appellant submits that for the purposes of Income Tax Act, previous year is defined in Section 3 to mean the financial year immediately preceding the assessment year. The proviso to that section is reproduced below for ready reference.

“Provided that, in the case of a business or profession newly set up, or a source of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession or, as the case may be, the date on which the source of income newly comes into existence and ending with the said financial year”.

1.1 In the case of a newly set up business, the date of “setting up to the business” is to be considered, for allowability of revenue expenses in the respective financial year, and not the date commencement of billing or realisation of revenue, as wrongly construed by the Assessing authorities.

1.2 The Madras High Court in Ascendas IT Park Chennai Ltd, Vs DCIT, (May 2016) while over ruling the Tribunal Order had observed that since Income Tax Act does not define “set up”, one would have to construe the date of setting up of business as being the initial stage in the chain of events leading to full fledged operations.

The Honourable Jurisdictional Court in the same Judgement differentiated this from the word “Preliminary Expenses” used in Section 35-D to conclude that the latter is incurred at a very nascent stage of activity, and is associated with an exploratory exercise to finalise commencement of business.

2. The Appellant submits that it has “set up” its business in the Financial Year 2014-15 (AY 2015-16). A Chronological sequence of events is presented is a tabular form herein below, to establish the same.

S.No.DateEventPaper Book Page
109.09.2014MOU for Logistic Service35
209.09.2014Appointment of Managing Director by Parent Company41
309.09.2014Date of Incorporation53
427.10.2014Bank Account opening date69
529.10.2014Date of receiving substantial amount in Bank towards Share Capital69
601.11.2014Rent agreement executed101
717.11.2014Appointment of Executive Assistant117
820.11.2014Service Tax Registration Certificate obtained133
920.11.2014Commercial taxes Registration123
1021.11.2014Asset Purchase dates127
1125.11.2014Import Export Code obtained137
1220.03.2015Auditor Certificate certifying Share Capital inflow139
1327.03.2015Company Secretary Certificate certifying share allotment141
1428.03.2015FCGPR Certificate Filing with RBI for inflow of foreign exchange towards Share Capital 

3. The Appellant submits that the Revenue Authorities have placed the Appellant in the same footing as a manufacturing concern, for which availability of infrastructure and manufacture of a product are precursors to setting of a business.

The Appellant’s case relates trading, which can be done even using Government/Private warehouses and through approved trade mechanisms as E-1 Sales/high seas sales etc.

4. The Appellant submits that it had attained a state of “having set up the business” in Financial Year 2014-15 by placing the following evidences.

4.1 Availability of Financial Resources.

4.2 Appointment of Personnel.

4.3 Leasing of place of work.

4.4 Obtention of statutory registrations and approvals.

4.1 Availability of Financial Resources

An amount of Rs.1.22 crores has been received into bank account as share capital and notably retained in current account signifying the intention of the Appellant keep himself in a state of readiness for business expenditure.

(Paper Book Page No. 69)

4.2 Appointment of Personnel

The parent Company had appointed a Managing Director on 11 September 2014, to initiate the incorporation of the Appellant Company and to further take all steps necessary for setting up and running the business. He has undertaken a set of tasks including preliminary discussions with suppliers & customers, appointment of support staff, and obtention of statutory approvals. An executive assistant has also been appointed on 17-11-2014.

(Paper Book Page No. 41)
(Paper Book Page No. 117)

4.3 Leasing of Premises

As a cost optimisation plan in the initial stages of business, the Appellant had leased out a residential cum office premises, for being used to run the activities of business.

(Paper Book Page No. 101)

4.4 Obtention of Statutory Approvals

The Appellant has obtained all the necessary Statutory registrations and approvals necessary thereby establishing the appointment of the stage of “setting up of business”.

1.PAN Card.(Paper Book Page No.67)
2.Import Export Code on 25-11-2014.(Paper Book Page No.137)
3.CST Registration on 20-11-214.(Paper Book Page No.125)
4.TNVAT Registration on 20-11-2014.(Paper Book Page No.123)

5. The Revenue Authorities had overtly misguided themselves into believing that billing and inflow of revenue is mandatory to signal the commencement of previous year, thereby failing to demarcate the fine line between “setting up of business” and “commencement of business”.

6. The order of the Learned Appellate Commissioner has relied on the observation of the Assessing Officer which fails due to following reasons:

6.1 The Learned Assessing Officer has mentioned that in Para 23 of Jurisdictional Court’s Order in Ascendas IT Park case (Supra). The Learned A.O. has misunderstood to the opening sentence in the Order suggesting the yardstick to be adopted in deciding the status of “set up business”. The Honourable Bench has concluded the same paragraph ends by laying emphasis on “set up” of business for the allowability, and gone a step ahead equating it to commencement of business. This has escaped the partial, but crucial attention of the Revenue Authorities.

6.2 The Order of the Learned Assessing Officer reference to a disclosure in Directors Report is misconstrued in so far as that these are routine disclosures made in commercial context commencement of business activities. The report merely mentions “business activities are yet to be commenced” and does not dwell into the legalities on whether the business has been set up or not. (Paper Book Page No. 179) Further the Delhi High Court in Dhoomketu Builders set aside the contention of Department which relied on comments in tax audit report regarding non commencement of business, stating that to be irrelevant because of the distinction between the commencement of business and setting up of the same.

6.3 The Order mentions that Director salary could be “anything but towards commencement of business”. While this could be true with respect to a Director who has equity stake in a closely held Company, in the Appellant’s case the Director is an employee appointed under contract as a Key Management Person (KMP) to set up the business & run the business, and is not a promoter. .

7. A reading of Para 7 of the Order of the Learned CIT (Appeals) clearly demonstrate that he has upheld the Order the A.O. based only on following aspects.

a) The test of whether business operations have started gets established only when income is earned.

b) The Assessee has not given proof of manufacturing/trading activity.

c) Disclosure in Director’s report that no business activities were conducted.

(Paper Book Page No. 13)

While existence the above aspects prove set up of business, the corollary is not true. In other words a business which has been “set up” NEED NOT carry all these attributes.

The Learned Assessing Officer ought to have relied on the wisdom bestowed through Judgements of the various Honourable Courts, including Jurisdictional Court, to carefully assess whether business has been set up, instead of relying on his own surmise about commencement of business activity.

8. The Order of the Learned Appellate Authority in Para 8 (Paper Book Page No. 15) has concluded that the expenses being legitimate ought to be available for being set off against future incomes. The Department has thus concluded the nature of expenses to be revenue in nature. In as much as these expenses are allowed to be written off over period of time in the Order, it serves no purpose to force the Appellant to defer the claim over a period of time as mentioned in the Order. The whole exercise is totally revenue neutral under a going concern concept.

9. The Appellant further submits the observations in the following Judgements which supports the contention of the Appellant.

9.1 In Ascendas IT Park Chennai Ltd, Para 21 of the Order, the Honourable Jurisdictional Court observed that one would have to construe the date of setting up of business as being the initial stage in the chain of events leading to full fledged business operations. In Para 25 of the same Judgement, the Assessee having traversed beyond stage of exploratory activity was in fact engaged in activity that was integral to profit earning apparatus.

9.2 In CIT Vs Axis Equity ITA Appeal No. 1204 of 2014, the Bombay High Court aligned with its earlier decision in the case of Western India Vegetable Products Ltd. wherein it was held that business is said to have been set up when it is established and ready to commence, and that all expenses incurred during the interregnum between setting up of business and commencement of business would be permissible deductions.

9.3 The Delhi High Court Judgement in the case of Carefour WC & C India (P) Ltd. in a case identical to the Appellant ((i.e) a trading entity) had noted the sequence of key events like employment of key persons, opening of bank account, incurring of routine business expense, discussions with customers etc. constituted “setting up of business” though actual sale and purchase happened in the subsequent year.

9.4 In an identical case of trading activity in the case of Samsung India Electronics, the Delhi High Court held that the expression setting up means, as defined in oxford dictionary, to place on foot or establish, and is in contradistinction to “commence”.

9.5 In the recent case of North Star Tech Park Pvt. Ltd., the ITAT, Ahmedabad in it order on 3rd October 2018 concluded in favour of the Assessee on the ground that assessee has recruited employees, and the assessee has realised income in the immediately succeeding assessment year.

9.6 The Delhi High Court in CIT Vs Arcane Developers (P) Ltd. upheld the ratio that setting up business takes place when business is ready and FIRST steps are taken.

9.7 In the case of Dhoomketu Builders the Delhi High Court has categorically emphasised the need to distinguish between commencement of business and setting up of business while ruling in favour of the Assessee.

9.8 The Delhi ITAT in the case of JCdecaux Advertising India (P) Ltd. articulated three stages in business operation Viz. (i) Setting up (ii) Post setting up before commencement (iii) Commencement and thereafter, while holding that in the case of a trader, setting up of a business means the stage up to which place of business is acquired and things necessary to start trading are done.

9.9 Besides this there are several Judgements some of which is given below, supporting the contentions of the Appellant.

1. CIT Vs Sarabhai Management Corporation (1991) 192 ITR 151 (SC) = 2002-TIOL-1052-SC-IT-LB.

2. CIT Vs Whirlporl India Ltd (2009) 318 ITR 347 = 2009-TIOL-426-HC-DEL-IT.

3. CIT Vs ESPN Software India (P) Ltd., (2008) 301 ITR 368 (Delhi) = 2008-TIOL-170-HC-DEL-IT.

4. CIT Vs Sauer Danfoss (P) Ltd. (2012) 208 Taxmann 50 (Delhi) = 2012-TIOL-329-HC-DEL-IT.

5. CIT Vs Franco Tosi Ingegnaria (2000) 241 ITR 168 (Madras) = 2003-TIOL-313-HC-MAD-IT.

6. CIT Vs Aspentech India (P) Ltd. (2010) 187 Taxmann 25 (Delhi).

For all the above reasons, the Appellant prays that the Honourable Tribunal may be pleased to pass an order as deemed appropriate on the merits of the case.

4. It was a submission that the assessee company was incorporated on 19.09.2014 and the assessee had incurred expenditure to the extent of Rs.15,12,593/- towards “employee benefit expenses” and Rs.32,24,751/- towards ‘other expenses’, totaling to Rs.47,37,344/-. It was a submission that on the ground that the Director’s Report for the Financial Year 2014-15 showed that the business activities of the assessee company were yet to start, the AO had disallowed the assessee’s claim of Revenue expenditure. It was a submission that in view of the decision of the Hon’ble High Court in the case of M/s.Ascendas IT Park Chennai Ltd., referred to supra, the assessee’s claim is liable to be allowed. Here, it must be mentioned that various other case laws have been quoted by the assessee in its written submissions, but none of them were discussed during the course of the hearing.

5. In reply, the Ld.DR submitted that before the AO also the decision of the Hon’ble High Court in the case of M/s.Ascendas IT Park Chennai Ltd., had been cited and the same had been distinguished clearly in Page Nos.4 & 5 of the Assessment Order. It was a further submission that the assessee has not produced any proof of having doing any specific business activity during the relevant assessment year.

6. On a specific query from the Bench, what is the nature of activity of the assessee, it was submitted that the assessee imports the navigation equipments and supply it to Original Equipment Manufacturers (in short ‘OEMs’) when asked, the Ld.AR as to the date of the first import to which the Ld.AR submitted that the first import was in June, 2016 and the first sale was in July, 2015. It was a submission that the Managing Director appointed was an employee and was not a shareholder.

7. We have also perused the P&L A/c, Balance sheet of the assessee company for the year ended 31.03.2015 which was shown in Page Nos.179 to 223 of the paper book. The Directors Report was at Page No.179. In the Director’s Report, under the highlights of performance, it has been categorically admitted that the year ended 31.03.2015 is the first year of operation of the assessee company and the business activities are yet to be commenced. It has also mentioned that the Directors are confident to commence the business activities soon. Page No.181 is the extract of the annual return for the year ended 31.03.2015 under the Companies Act. The turnover of the assessee company has been shown at NIL. Page No.193 is the statement of P&L A/c for the year ended 31.03.2015. The Revenue is shown at NIL. The Excise Duty (products which have dealt with by the assessee being an excisable product) is shown at NIL. Other income being interest income shown at Page No.129. Salaries are shown at 13,51,285/-. Staff welfare is shown at Rs.1,61,308/-. There were no details about number of employees. The assessee is dealing with M/s.Hyundai Motor India Ltd., and the salary payment is to only one employee being the Director. The decision the case of Ascendas is not applicable in the assessee’s case as the primary requirement of funds and the certificate for inflow has been received only on 28.03.2015 and nothing has been shown to prove commencement of business. Thus, clearly nothing has been shown that the assessee has started any business activity during the relevant assessment year. This being so, we do not find any reason to interfere with the order of the Ld.CIT(A) and consequently, uphold the same.

8. In the result, the appeal filed by the assessee stands dismissed.

(Order pronounced in the Open Court on the 10.06.2019)

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