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2025 (6) TMI 406 - AT - Income TaxDisallowing the expenditure as no business of the Assessee undertaken during the Assessment Year - distinction between commencement of business and setting up of a business . HELD THAT - On a conjoint reading of sections 3 4 and 28 of the Act the expenses incurred after the date of setting up of the business are eligible for deduction subject to fulfillment of the other provisions of the Act. On the other hand expenses incurred before the date of setting up of the business are liable to be disallowed. A business can be said to have been set up when it is ready to discharge the function for which it was set up and the actual commencement of revenue generating activity does not have any bearing for determining the date of setting up of business. The date of setting up of business is relevant for computation of income under the head Business and Profession and allowance of revenue expenditure incurred after that date. Assessee which is an investment company would be regarded to have set up its business when it was ready to make investment i.e. when it received funds from making investment in its bank account and it is evident from the factum of first investment made by the Assessee as on 31/08/2006 in the shares of Flextronics Software System Ltd. (a software development company which later merged with the Assessee) by using funds received by the Assessee by way of issue of remedial optionally convertible noncumulative preference shares in its bank accounts. Thus we find no error in the order of the Ld. CIT(A) holding that the Assessee has set up its business on 11/08/2006 and the expenses incurred thereafter ought to be allowed as deduction subjection to the provision of law. Mere entries in the books of accounts of the Assessee are not determinative of ambit of taxation under the provision of Act. If an item of income/expenditure is taxable/deductible the same must be taken into account as per the provision of the Act not as per the mere books entry. The said view has been fortified in the Judgments of Kedarnath Jute Mfg. Co Ltd vs CIT 1971 (8) TMI 10 - SUPREME COURT Sutlej Cotton Mills Ltd. 1978 (9) TMI 1 - SUPREME COURT and Asian Hotels Ltd. 2023 (10) TMI 514 - DELHI HIGH COURT Appeal of the Revenue is dismissed.
The core legal questions considered by the Tribunal in this appeal include:
1. Whether the assessee company had commenced or set up its business during the relevant previous year, specifically on 11/08/2006, despite the absence of active business operations or revenue-generating activities. 2. Whether the expenditure claimed by the assessee during the year under consideration qualifies as deductible business expenditure under the Income Tax Act, 1961, given that the shares purchased were classified as investments and not stock-in-trade. 3. The correct interpretation and application of the concepts of "setting up" versus "commencement" of business for the purposes of taxation and allowance of business expenditure under the Act. Issue 1: Determination of the Date of Setting Up or Commencement of Business Legal Framework and Precedents: The Tribunal examined the definitions and provisions under sections 2(34), 3, 4, and 28(i) of the Income Tax Act, 1961. Section 2(34) defines "previous year," and the proviso thereto clarifies that for a newly set-up business, the previous year begins from the date of setting up the business. Section 28(i) taxes profits and gains of any business carried on during the previous year. The key legal principle is that the date of "setting up" the business, not necessarily the date of "commencement," determines the start of the previous year for tax purposes and the eligibility for claiming business expenditure. Judicial precedents relied upon include the Bombay High Court decision in Western India Vegetable Products Ltd. v. CIT, which distinguished between "setting up" and "commencement" of business, holding that expenses incurred after setting up but before commencement are deductible. This principle was subsequently approved by the Supreme Court. The Delhi High Court in CIT v. Dhoomketu Builders and Development (P) Ltd. reinforced this distinction and emphasized that readiness to commence business activities constitutes setting up, even if actual revenue-generating operations have not yet begun. Similar ratios were cited from other Delhi High Court cases involving Hughes Escorts Communications Ltd., LG Electronics (India) Ltd., and ESPN Software India (P) Ltd. Court's Interpretation and Reasoning: The Tribunal accepted that the assessee was incorporated on 14/06/2006 and obtained the certificate of commencement of business on 11/08/2006. The assessee raised funds through issuance of shares and made its first investment in the shares of its subsidiary on 31/08/2006. These acts demonstrated that the business was "set up" and ready to carry out its objects of investment in software companies. The Tribunal emphasized that "setting up" means the business is established and ready to function, and that actual commencement of income-generating activities is not necessary for this determination. The readiness was evidenced by the bank statements showing receipt of funds, allotment of shares, and investment transactions. The Tribunal rejected the Revenue's argument that the absence of active business operations or classification of shares as investments negated the setting up of business. Key Evidence and Findings: The Tribunal relied on documentary evidence including the certificate of incorporation, certificate of commencement, share allotment records, investment transactions, bank statements, notes to accounts, and the amalgamation approval by the High Court. These collectively demonstrated that the assessee had established its business and was operationally ready within the relevant financial year. Application of Law to Facts: Applying the statutory provisions and judicial precedents, the Tribunal concluded that the assessee's business was set up on 11/08/2006, marking the start of the previous year for the purposes of income computation and allowance of business expenditure. Treatment of Competing Arguments: The Revenue contended that mere classification of shares as investments and absence of active business activities precluded commencement or setting up of business. The Tribunal held that book entries alone do not determine tax treatment and that the substance of the transaction and readiness to carry on business are decisive. The Tribunal also noted that income or revenue generation is not a prerequisite to establish the setting up of business. Conclusion: The Tribunal upheld the CIT(A)'s finding that the assessee had set up its business on 11/08/2006 and was entitled to claim expenditure incurred thereafter as business expenditure. Issue 2: Allowability of Expenditure Claimed as Business Expenditure Legal Framework and Precedents: Under the Income Tax Act, expenses incurred wholly and exclusively for the purpose of the business are deductible. The distinction between capital and revenue expenditure, and between business expenditure and investment-related expenses, is fundamental. The Tribunal referred to precedents including Kedarnath Jute Mfg. Co Ltd v. CIT, Sutlej Cotton Mills Ltd. v. CIT, and Asian Hotels Ltd. v. CIT, which establish that the tax treatment depends on the nature of income or expenditure and the provisions of the Act rather than mere accounting classification. Court's Interpretation and Reasoning: The Tribunal observed that the assessee's business was that of an investment company engaged in acquiring shares of subsidiary companies. The expenditure incurred after the setting up of the business was related to the business of investing and thus qualifies as business expenditure. The Tribunal rejected the Revenue's contention that classification of shares as investments precluded the expenditure from being business expenditure. Key Evidence and Findings: The Tribunal considered the financial statements, notes to accounts, and transaction details which showed that the expenses were incurred in connection with the business of investment. The Tribunal also noted that the assessee had raised funds and deployed them in investments consistent with its business objectives. Application of Law to Facts: The Tribunal applied the principle that the tax treatment must follow the legal nature and purpose of the expenditure, not merely the accounting treatment. Since the business was set up and operational in making investments, related expenditures were rightly allowed as business expenses. Treatment of Competing Arguments: The Revenue's argument that investment-related expenses are not business expenses was countered by the Tribunal's finding that the assessee's business itself was investment activity. The Tribunal emphasized that mere book classification cannot override the statutory provisions. Conclusion: The Tribunal upheld the CIT(A)'s deletion of the disallowance and allowed the expenditure as deductible business expenditure. Significant Holdings The Tribunal preserved the following crucial legal reasoning: "There is a clear distinction between 'commencement of business' and 'setting up of a business'. For income tax purposes, the 'setting up of the business' and not the 'commencement of business' is to be considered. When a business is established and is ready to commence business then it can be said that business that it is set up. There may, however, be an interval between 'setting up of the business' and 'commencement of the business' and all expenses incurred during that interval would be permissible deduction." "The mere entries in the books of accounts of the Assessee are not determinative of ambit of taxation under the provision of Act. If an item of income/expenditure is taxable/deductible, the same must be taken into account as per the provision of the Act not as per the mere books entry." Core principles established include:
Final determinations on the issues are: (i) The assessee company had set up its business on 11/08/2006, the date of certificate of commencement of business, supported by investment activities and receipt of funds. (ii) The expenditure incurred after the setting up of business is allowable as business expenditure under the Income Tax Act. (iii) The appeal filed by the Department of Revenue against the CIT(A)'s order deleting the disallowance was dismissed for lack of merit.
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